j. - secwithdravving its initial proposal and refiling the proposal as file no. sr-bats-2015-101...
TRANSCRIPT
November 6 2015
Brent J Fields Secretary Securities and Exchange Commission 100 F Street NE Washington DC 20549-1090
RE Response lo Comment Letters Securities Exchange Act Release No 34-7 5693 File No SR-BATS-2015-57 as modified by Amendment 1
Dear Mr Fields
BATS Exchange Inc (BATS or Exchange) appreciates the opportunity lo respond to comment letters submitted in connection with SEC Release No 34-75693 File No SR-BATSshy2015-57 as modified by Amendment 1 (Initial Proposal) After careful analysis of the submitted commentary and simultaneous with the submission of this letter the Exchange is withdravving its Initial Proposal and refiling the proposal as File No SR-BATS-2015-101 (Revised Proposal) In this letter the Exchange describes the purpose of the Initial Proposal and the revisions made in the Revised Proposal and the Exchange addresses the comment letters to the Initial Proposal in light of the Revised Proposal For the reasons set forth in the Initial Proposal the Revised Proposal and in this response the Exchange believes that the Revised Proposal lo adopt proposed Rules 817 and 1215 is consistent v1ith Section 6(b)(5) of the Securities Exchange Act of 1934 (Act) 1 The Exchange therefore respectfully requests that the Securities and Exchange Commission (Conunission) approve the Revised Proposal
l Background
A The Exchange Seeks to Protect Market Participants From Continued Harm During Investigation and E1forcement ofViolations
As explained in the Initial Proposal as a national securities exchange the Exchange is required lo be organized and lo have the capacity to enforce compliance by its Members and persons associated with its Members with the Act the rules and regulations thereunder and the Exchanges Rules (Rules)2 The Exchanges Rules are required to be designed to prevent fraudulent and manipulative acts and practices lo promote just and equitable principles of trade and in general to protect investors and the public interest3 To fulfill these requirements the Exchange has developed a comprehensive regulatory program that includes surveil lance of trading activity that is both operated by Exchange staff and by staff of the Financial Industry
15 USC 78f(b)(5)
2 ld al 78f(b )(I)
3 Id at 78f(b)(5)
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Regulatory Authority (FINRA) pursuant to a Regulatory Services Agreement (RSA) When disruptive potentially manipulative or improper quoting and trading activity is identified the Exchange or FIN RA (acting as an agent of the Exchange) conducts an investigation into the activity requesting additional information from the Member or Members involved To the extent violations of the Act the rules and regulations thereunder or Exchange Rules have been identified and confirmed the Exchange or FINRA as its agent will commence the enforcement process which might result in among other things a censure a requirement to take certain remedial actions one or more restrictions on future business activities a monetary fine or even a temporary or permanent ban from the securities industry
Due to the often complex nature of disruptive and potentially manipulative improper quoting and trading activity and the gravity of the potential remedial actions at the Exchanges disposal the Exchange believes it is generally necessary to thoroughly investigate potential violations and provide adequate due process to the subject Member during enforcement proceedings The Exchange has observed however certain cases of the man ipulative practices of layering and spoofing that are so obvious and uncomplicated that they leave little to question regarding the impropriety of the behavior These cases of activity that display clear patterns of improper quoting and trading behavior are afforded the same thorough process as more nuanced cases of possible disruptive behavior that is potentially defensible As a result a Member - or in many instances the Members clients - are effectively permitted to continue illegal disruptive behavior that harms the market and its participants pending the completion of the lengthy investigation and enforcement process
The Exchange believes this result is unacceptable Indeed the Exchange has the obligation to prevent fraudulent and manipulat ive acts and practices to promote just and equitable principles of trade and in general to protect investors and the public interest4 To further fulfill this obligation the Exchange has proposed to specifically define and prohibit the most egregious cases of layering and spoofing5 and to provide the Exchange middotwith an expedited hearing process in which a Member who continuously violates the prohibition or continues to permit its client to violate the prohibition can be suspended in a matter of weeks rather than years The suspension is designed to remain in place for only as long as necessary to cause a Member to cease and desist illegal layering andor spoofing practices If a Member is suspended under the proposed Rule the Member is permitted to apply via an expedited process to have the order modified set aside limited or revoked at any time after the Member is served with a suspension order The Exchange believes this procedure appropriately places the burden on the offending Member to show that it has halted its harmful practice or its client s harmful practice before being permitted to resume activity on the Exchange rather than requiring the market to bear the harm ofcontinued manipulative conduct until the Exchange fina lly disposes of the Member s case
lei
The Exchange notes that all instances of layering and spoofing are already prohibited by the broader proscription of 17 CFR 240 l Ob-5 against deceptive and manipu lati ve practices See also Ruic 12 I Rule 122
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B The initial Proposal
In the Initial Proposal the Exchange proposed to adopt nevl Rule 817 to establish expedited procedures for issuing suspension orders immediately prohibiting a Member from conducting continued layering or spoofing activity on the Exchange and establishing the procedures to permit the Exchange to order a Member cease and desist providing a client of the Member access to the Exchange when the client of the Member is conducting layering or spoofing activity in violation of proposed Rule 1215 The definit ions of prohibited Layering and Spoofing contained in Rule 1215 are designed to encompass conduct the Exchange has observed in the most egregious layering and spoofing cases Proposed Rule 1215 prohibits Layering and Spoofing as follows
12 15 Layering and Spoofing Prohibited
No member shall engage in or facilitate layering or spoofing activity on the Exchange as described in Interpretation and Policy 0 I of this Rule includ ing acting in concert vvith other persons to effect such activity
interpretations and Policies
0 I Layering For purposes of this Rule layering activity shall include a frequent pattern in which the following facts are present
(a) a party enters multiple limit orders on one side o f the market at various price levels (the Layering Orders) and
(b) fol lowing the entry or the Layering Orders the level of supply and demand for the security changes and
(c) the party enters one or more orders on the opposite side of the market o f the Layering Orders (the Contra-Side Orders) that are subsequently executed and
(d) follmving the execution of the Contra-Side Orders the party cancels the Layering Orders
02 Spoofing For purposes of this Rule spoofing activity shall include a frequent pattern in which the following facts are present
(a) a party narrows the spread fo r a security by placing an order inside the NBBO (the Spoofing Order) and
(b) the party then submits an order on the opposite side of the market (Contra-Side Order) that executes against another market
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participant that joined the new inside market established by the Spoofing Order
03 Applicability For purposes of this Rule layering activity and spoofing activity shall include a frequent pattern in which the facts listed above are present Unless otherwise indicated the order of the events indicating the pattern does not modify the applicability of the Rule Further layering activity and spoofing activity includes a pattern or practice in which all of the layering or spoofing activity is conducted on the Exchange as well as a pattern or practice in which some portion of the layering or spoofing activity is conducted on the Exchange and the other portions of the layering or spoofing activity is conducted on one or more other exchanges
Essentially proposed Rule 81 7 provides an expedited suspension hearing process to remedy violations of proposed Rule 12 15 A Member vho is accused of a violation or hose client is accused of a violation (Subject Member) is provided notice requesting that the Subject Member either take action or refrain from action and a detailed statement of facts to support the allegations of a violation of Rule 12 15 signed by a person with knowledge of the factual allegations Rule 817 then provides for the expedited appointment of a hearing panel and a procedure by which the Subject Member may move to disqualify a member of the hearing panel The Subject Member then must be served with a notice of hearing not later than 7 days before the hearing The hearing shall take place not less than 15 days after the initiation of suspension proceedings under Rule 817 After the hearing the hearing panel must issue a written decision stating whether a suspens ion order shall be imposed not later than I 0 days after the panel receives the hearing transcript Under Rule 81 7 a suspension order shall be imposed if the Hearing Panel finds
(A) by a preponderance of the evidence that the alleged violation specified in the notice has occurred and
(B) that the violative conduct or continuation thereof is likely to result in significant market disruption or other significant harm to investors
lf the hearing panel imposes a suspension order the order shall (1 ) set forth the alleged violati on and the significant market disrnption or other significant harm to investors that is likely to result middotVithout the issuance of an order (2) describe in reasonable detail the act or acts the Subject Member is to take or refrain from taking and (3) include the date and hour of the orders issuance A suspension order under Rule 8 17 shall be limited to orderi ng the Subject Member cease and desist from violating Rule 12 15 andor providing access to the Exchange to a client of the Subject Member that is causing violations o f Rule 1215 The Initial Proposal also provides sanctions for the Subject Members violation of a suspension order
The Initial Proposal provides that any sanction imposed pmsuant to proposed Rule 817 is final and immediately effective The proposed Rule dictates that the filing of an application for
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review with the SEC does not stay any sanction imposed under the rule unless the SEC orders otherwise Finally the proposed Rule permits the Subject Member who is served with a suspension order to apply to the Hearing Panel to request the order be modified set aside limited or revoked The Hearing Panel must provide an expedited response to the application within ten days
C Withdrawal and Revision of the initial Proposal
After review and consideration of comments from the public the Exchange has Vithdrawn the Initial Proposal and refiled the Revised Proposal The Revised Proposal modifies Rule 12 15 to replace the terms Layering and Spoofing with the terms Disruptive Quoting and Trading Activity Type l and Disruptive Quoting and Trading Act ivity Type 2 respectively The Revised Proposal also updates the terminology in Rules 8 17 and 12 1 5 to reflect the revised terminology of Rule 1215
In the Revised Proposal the Exchange a lso removes subparagraph ( f) of proposed Rule 8 17 contained in the Initial Proposal Subparagraph (f) provided a process for sanctioning violations of a suspension order It is the Exchanges position that a suspension order issued under Rule 8 17 is enforceable against the Subject Member and no additional process is required to discipline the violation of an order thereby making subparagraph (f) of proposed Rule 8 I 7 in the Initial Proposal superfluous
Finally the Revised proposal modifies subparagraph (d)(2)(A) of proposed Rule 81 7 to clarify that a suspension order is to order that a Member served vi th such order is suspended from access to the Exchange unless and until the Member complies with the cease and desist provisions of the order
II Conunent Letters and Response
Five Comment Letters were submitted to the SEC by four different commenters in response to the Initial Proposal Sec Letters from Samuel F Lek Chief Executive Officer Lek Securities Corporation dated September 3 2015 and September 18 201 5 (Lek Letters) Letter fro m RT Leuchtkafer dated September 4 201 5 (Leuchtkafer Letter) Letter from Mary Ami Burns Chief Operating Officer FIA Principal Traders Group dated September 9 20 I 5 ( FTA PTO Letter) and Comment from Teresa B Machado dated August 19 201 5 (Machado Comment) (co llectively the Comment Letters) The Exchange appreciates the FTA PTO Letters support of the Exchanges objecti ves and appreciates the specific concerns rai sed in the FIA PTO Letter Further the Exchange appreciates the Lek Letters and the Leuchtkafer Letters respective critiques of the Initial Proposal The Exchange also appreciates the Machado Comment s support of the Initial Proposal The Exchange responds belo to the concerns and criti cisms raised in the Comment Letters
A Definitions of Layering and Spoofing Contained in Proposed Rule 12 15
The Lek Letters raise the concern that the definitions of Layering and Spoofing in Proposed Rule I 2 15 are too broad encompassing activities that are not manipulative and
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accordingly do not violate the anti-fraud provisions of the securities laws6 The FIA PTG Letter raises the concern that the definitions of Layering and Spoofing in the Initial Proposal are overbroad and may wrongly penalize legitimate good faith actions7 Specifically the FIA PTG Letter takes issue with the lack of an express intent element in the definition of Layering and Spoofing8
On the other hand the Leuchtkafer Letter asserts that the proposed definitions of Layering and Spoofing are much too narrow9 The Leuchtkafer Letter asserts that the Proposed Rule defines Layering and Spoofing as very certain kind[ s] of act[ s] apparently exclusive of any other act[s] 10 The Leuchtkafer Letter is concerned that the proposed definitions will insulate from enforcement manipulative acts that do not fall tidily within those definitions11
The Exchange agrees that the harmful practices of layering and spoofing are defined by an intent element Indeed intent is often what distinguishes manipulative fraudulent practices from legitimate good faith behavior The Exchange acknowledged this in the Initial Proposal Proposed Rule 1215 includes an intent element by defining the respective disrnptive quoting and trading activities as a frequent pattern of the enumerated conduct Such a frequent pattern evidences manipulative intent 12
6 See September 3 2015 Lek Letter 1 The Lek Letters also lodge an array of semantic arguments against the proposed rule The Lek Letters argue that the rule is impermissibly vague because it uses the terms frequent pattern and multiple without further definition It is the Exchanges position that these terms are generally understood by their plain and ordinary meanings and therefore adequately describe the proscribed conduct
7 FIA PTG Letter 3-4 s FIA PTG Letter 3 The Lek Letters also argue that because layered orders could
theoretically be executed a trader engaged in layering could not possibly intend the orders not be executed even if he hopes that the orders do not execute September 3 2015 Lek Letter 4 This is a logical fallacy akin to arguing that a murderer did not intend to kill because although he hoped that the bullet he aimed and fired would kill his victim it was possible the bullet could miss The ultimate result of an act is not determinative of intent Neither are the possible results Instead intent is a mental slate that must exist at the time of the act in question
9 Leuchtkafer Letter 1 JO Id at 2
II Id at 3 12 The Exchange has observed that the frequent pattern of the proscribed activities is
typically the key indication of intent in layering and spoofing cases While additional corroborating information is sometimes considered to prove intent - such as contemporaneous communications or party testimony - in the Exchanges experience that
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The Leuchtkafer Letters concern that the definition of certain practices as Layering and Spoofing could be read to exclude other layering and spoofing practices is also well-taken The purpose or proposed Rule 12 15 however is not to provide universal definitions of layering and spoofing Rather once certain obvious and uncomplicated cases of disruptive and manipulative behavior or particularly harmful behavior has been identified the purpose of the proposed Rule is to initiate an expedited suspension proceeding in order to stop the behavior from continuing on the Exchange if a Member is engaging in or facilitating layering or spoofing activity and the Member has received sufficient notice vith an opportunity to respond but such activity has not ceased13 The Exchange has identified certain patterns and practices that are hallmarks of the most egregious spoofing andor layering conduct In the initial proposed Rule 12 15 the Exchange defined this conduct as Spoofing and Layering
But as discussed by the FIA PTO Letter and the Lek Letters non-spoofing and nonshylayering activity could conceivably fall within the definitions of Layering and Spoofing in the Initial Proposal and as pointed out by the Leuchtkafer Letter manipulative layering and spoofing activity could conceivably fall outside the proposed definitions Since the purpose of proposed Rules 87 and 1215 is not to provide a precise definition of layering and spoofing but to protect market participants from the harm caused by a Subject Members refusal to cease obvious disruptive market practices the Exchange has modified the defined terms in proposed Rule 1215 in the Revised Proposal The defined term Layering in initial Proposed Rule 12 15 is now labeled Disruptive Quoting and Trading Activity Type l The defined term Spoofing in the initial Proposed Rule is now labeled Disruptive Quoting and Trading Activity Type 2
The Exchange believes this change in terminology advances the objective to protect market participants from harmful manipulative behavior while alleviating both the concern that the definitions of Layering and Spoofing could insulate undefined manipulative conduct and the concern that the Proposed Rule would give the Exchange the ability to prove Layering and Spoofing v1ithout expressly proving intent This change in terminology - paired middotwith the expedited suspension order review application process - highlights that the proposed Rule 817 is a market protection rule designed to halt a very specific readily identifiable type of illegal
information typically serves only to confirm the manipulative intent indicated by a repeated pattern of disruptive activity While this corroboration Viii sti ll be obtained where available in an ultimate enfo rcement action the Exchange believes that it is unacceptable for the market to cont inue to be harmed during the time between the initial identification of manipulative intent from a frequent pattern of manipulative conduct and the discovery of corroborat ing evidence of that manipulative intent At the same time the Exchange believes that some indication of intent must exist to take action under the proposed Rules The Exchange therefore proposes to balance these competing interests by requiring a showing or a frequent pattern of disruptive activity - the most prominent badge of intent - before a suspension order may issue
See Initial Proposal Amendment No I at 5037 1
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trading activity rather than an attempt to define and punish layering and spoofing in every conceivable context 14
B Process ofExpedited Client Smpension Hearing Proceeding
Proposed Rule 817 provides a mechanism to swiHly halt egregious manipulative trading activity by Members andor clients of Members that ignore the Exchanges requests to cease the manipulative practices The Proposal provides an innovative mechanism to protect market participants from rogue clients andor Members who heretofore have been free to continue their manipulative activities pending the investigation and enforcement of their violations
The Lek Letters raise concerns regarding the expedited process for the proposed suspension proceedings15 The Lek Letters argue that the Exchange has no authority to enact the proposed Rule because the Exchange does not have jurisdiction over the clients of Members of the Exchange and that the proposed proceeding does not provide due process to a Members client that is the subject of a suspension order 16 Finally the Lek Letters argue that the proposed Expedited Client Suspension Hearing is a summary proceeding that violates the Act 17 The FIA PTO Letter on the other hand believes the Exchange s investigation notice and hearing processes described in connection with proposed Rule 817 are reasonable but suggests the process described in the Initial Proposal should be provided in an alternative format - eg as part of the proposed Rules as interpretive guidance or as FAQs 18
1 The Exchange Has Jurisdiction Over Its Members for Misconduct of a Members Client
The Lek Letters argument that the Exchange lacks jurisdiction to remedy a Members clients misconduct is mistaken As a condition of Exchange access Rule I l 3(a) requires a Member to agree to the Exchanges User Agreement which states
Except as otherwise provided herein with respect to all orders submitted to Exchange by User it is the sole responsibility of User to ensure compliance by itself its customers and its representatives with all applicable United States federal and state laws rules and regulations as well as those of FIN RA or any
14 lt is the Exchanges position that layering and spoofing are already prohibited illegal practices and at this time it is not necessary to separately define those already illegal practices See 17 CFR 240 1 Ob-5 Rule 12 1 Rule 122 The Exchange of course will revisit the issue if the need arises to specifically define layering and spoofing beyond the current generally accepted definitions of the prohibited illegal practices
15 September 3 2015 Lek Letter 5
16 kl 17 kl 18 FIA PTO Letter 2
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other self-regulatory organization of which the User is a member to the extent applicable to User User represents and warrants that it is and will remain responsible for its use of Exchange and the use of Exchange by any of its employees customers or agents or if User is a member of Exchange by any person vhich has entered into a sponsorship arrangement vith User to use Exchange (a Sponsored Participant)
Under the Exchange Rules and the User Agreement therefore a Members clients violation of the Act andor the Rules is charged to the Member
Rule 81 confers jurisdiction to the Exchange over [a] Member who is alleged to have violated or aided and abetted a violation of any provision of the Act or the rules and regulations promulgated thereunder or any provision of the Certificate oflncorporation By-Laws or Rules of the Exchange or any interpretation thereof or any resolution or order of the Board or appropriate Exchange committee The Exchange Rules therefore unquestionably confer jurisdiction to the Exchange to discipline its Members for a Members client s violations of the Act and the Exchanges Rules This jurisdiction over a Member for a clients actions is not only permissible - it is essential for the effective regulation of the Exchange 19 Because the Exchange has jurisdiction over a Member for the Members client s violations the Exchange has jurisdiction to enforce proposed Rule 817
The Lek Letters concern regarding the alleged lack of process provided to a Subject Members client is similarly misguided Because the Subject Member has ultimate responsibility for its clients actions and because proposed Rule 817 imposes discipline against the Subject Member - not the client - for the clients violations due process to the Subject Member is sufficient While the Exchange recognizes that the client may be adversely affected by the discipline against the Subject Member there is nothing in the proposed Rules that prevents a Subject Members client from participating in an expedited suspension hearing To the contrary the Exchange Velcomes the participation of the client at the hearing Because the suspension order is entered against the Subject Member however and not the client there is no due process that must be afforded the Subject Member s client
2 The Expedited Client Suspension Hearing Provides Due Process Under the Act to the Subject Member
The Lek Letters assert that the proposed expedited client suspension hearing would violate the Act because it is a summary proceeding not authorized by Section 6(d)(3) of the Act This assertion is incorrect because the proposed expedited client suspension proceeding is not a summary proceeding under Section 6(d)(3)
The Lek Letters assertion that the Exchange has no jurisdiction over a Member for a Members clients conduct would leave the Exchange helpless to enforce its own rules unless the member voluntarily cooperates with the enforcement process Such a result is obviously untenable and fli es in the face of the Exchanges obligation to enforce securities laws under the Act
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The suspension by summary proceeding permitted by Section 6(d)(3) is imposed prior to notice to the Member and an opportunity to be heard20 In contrast the proposed expedited client suspension hearing is governed by Section 6(d)(2) which provides the process for determining whether a person shall be denied membership barred from becoming associated with a member or prohibited or limited with respect to access to services offered by the exchange or a member thereof 21 As required by Section 6(d)(2) the proposed expedited client suspension hearing notif[ies] such person of and give[s] him an opportunity to be heard upon the specific grounds for denial bar or prohibition or limitation under consideration and keep[s] a record22 The expedited client suspension hearing proceeding therefore provides the clue process required under the Act
The Lek Letters also complain that the proposed expedited client suspension hearing proceeding is unfair because it does not provide sufficient time for discovery after the Exchange initiates the process As detailed in the Initial Proposal hovever the Exchange only intends to initiate the expedited client suspension hearing proceeding after an initial investigation and after the Exchange contacts the Member responsible for the orders to request an explanation of the activity and any additional relevant information Further the investigation and enforcement proceeding do not terminate upon the entry of a suspension order Discovery 1ill proceed as it would during any other enforcement action lf during the discovery process a Subject Member discovers information it believes to be exculpatory the proposed Rule allows a Subject Member [a]t any time after the [Subject Member] is served with a suspension order to apply to the Hearing Panel to have the order modified set aside limited or revoked Proposed Rule 817 merely places the burden on the Subject Member to show that it has halted its harmful practice or its clients harmful practice before being permitted to resume activity on the Exchange rather than requiring the market to bear the harm of manipulative conduct during the time-consuming discovery process Proposed Rule 817 therefore is not unfair - it is indeed fairer because it imposes the consequences of a Subject Member s harmful conduct on the Subject Member rather than imposing those consequences on the entire market
3 The Initial Proposal Clearly Defines the Parameters of Use of Proposed Rule 817
The Initial Proposal and Revised Proposal acknOmiddotVledge that the formidable power and discretion provided by proposed Rule 817 must be exercised only in the most egregious cases after a Subject Member has been given ample notice and opportunity to cease and desist the manipulative practices prohibited by the proposed Rule While the FIA PTO Letter suggests the Exchange include the process in other places the Exchange believes that the process of proposed Rule 817 and its proposed circumstances of use are clearly detailed in the Revised Proposal and would not be further clarified by repetition
20 15 USC 78f(d)(3)
21 lei at 78f( d)(2)
22 Id
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C Layering and Spoltfing Are Fraudulent Manipulative and Illegal Prnclices
Although many of the issues raised by the Lek Letters address the proposed definition of Layering and Spoofing in the Initial Proposal much of the Lek Letters argument appears to challenge the existing prohibitions in the Act against the manipulative and deceptive practices of layering and spoofing23 In fact the Lek Letters go so far as to argue that a prohibition of layering and spoofing would violate Section 6(b)(5) of the Act24
As layering and spoofing are fraudulent and manipulative practices prohibited by the Act the proposed Rules prohibiting those practices comports with Section 6(b)(5) and advances the Acts purposes Further the proposed Rules are neither anticompetitive nor unfairly discriminatory in violation of the Act as it only disciplines prohibited illegal behavior Proposed Rules 817 and I 2 I 5 therefore are consistent with the Act
III Conclusion
For the foregoing reasons the Exchange respectfully requests the Commission approve the Revised Proposal
Very truly yours
~ Anders Franzon VP Associate General Counsel
cc Stephen Luparello Director Division of Trading amp Markets David Shillman Associate Director Division ofTrading amp Markets David Liu Senior Special Counsel Division of Trading amp Markets
23 See 17 CFR 240 I Ob-5 Rule 121 Rule 122 24 September 3 2015 Lek Letter 3-6
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Regulatory Authority (FINRA) pursuant to a Regulatory Services Agreement (RSA) When disruptive potentially manipulative or improper quoting and trading activity is identified the Exchange or FIN RA (acting as an agent of the Exchange) conducts an investigation into the activity requesting additional information from the Member or Members involved To the extent violations of the Act the rules and regulations thereunder or Exchange Rules have been identified and confirmed the Exchange or FINRA as its agent will commence the enforcement process which might result in among other things a censure a requirement to take certain remedial actions one or more restrictions on future business activities a monetary fine or even a temporary or permanent ban from the securities industry
Due to the often complex nature of disruptive and potentially manipulative improper quoting and trading activity and the gravity of the potential remedial actions at the Exchanges disposal the Exchange believes it is generally necessary to thoroughly investigate potential violations and provide adequate due process to the subject Member during enforcement proceedings The Exchange has observed however certain cases of the man ipulative practices of layering and spoofing that are so obvious and uncomplicated that they leave little to question regarding the impropriety of the behavior These cases of activity that display clear patterns of improper quoting and trading behavior are afforded the same thorough process as more nuanced cases of possible disruptive behavior that is potentially defensible As a result a Member - or in many instances the Members clients - are effectively permitted to continue illegal disruptive behavior that harms the market and its participants pending the completion of the lengthy investigation and enforcement process
The Exchange believes this result is unacceptable Indeed the Exchange has the obligation to prevent fraudulent and manipulat ive acts and practices to promote just and equitable principles of trade and in general to protect investors and the public interest4 To further fulfill this obligation the Exchange has proposed to specifically define and prohibit the most egregious cases of layering and spoofing5 and to provide the Exchange middotwith an expedited hearing process in which a Member who continuously violates the prohibition or continues to permit its client to violate the prohibition can be suspended in a matter of weeks rather than years The suspension is designed to remain in place for only as long as necessary to cause a Member to cease and desist illegal layering andor spoofing practices If a Member is suspended under the proposed Rule the Member is permitted to apply via an expedited process to have the order modified set aside limited or revoked at any time after the Member is served with a suspension order The Exchange believes this procedure appropriately places the burden on the offending Member to show that it has halted its harmful practice or its client s harmful practice before being permitted to resume activity on the Exchange rather than requiring the market to bear the harm ofcontinued manipulative conduct until the Exchange fina lly disposes of the Member s case
lei
The Exchange notes that all instances of layering and spoofing are already prohibited by the broader proscription of 17 CFR 240 l Ob-5 against deceptive and manipu lati ve practices See also Ruic 12 I Rule 122
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B The initial Proposal
In the Initial Proposal the Exchange proposed to adopt nevl Rule 817 to establish expedited procedures for issuing suspension orders immediately prohibiting a Member from conducting continued layering or spoofing activity on the Exchange and establishing the procedures to permit the Exchange to order a Member cease and desist providing a client of the Member access to the Exchange when the client of the Member is conducting layering or spoofing activity in violation of proposed Rule 1215 The definit ions of prohibited Layering and Spoofing contained in Rule 1215 are designed to encompass conduct the Exchange has observed in the most egregious layering and spoofing cases Proposed Rule 1215 prohibits Layering and Spoofing as follows
12 15 Layering and Spoofing Prohibited
No member shall engage in or facilitate layering or spoofing activity on the Exchange as described in Interpretation and Policy 0 I of this Rule includ ing acting in concert vvith other persons to effect such activity
interpretations and Policies
0 I Layering For purposes of this Rule layering activity shall include a frequent pattern in which the following facts are present
(a) a party enters multiple limit orders on one side o f the market at various price levels (the Layering Orders) and
(b) fol lowing the entry or the Layering Orders the level of supply and demand for the security changes and
(c) the party enters one or more orders on the opposite side of the market o f the Layering Orders (the Contra-Side Orders) that are subsequently executed and
(d) follmving the execution of the Contra-Side Orders the party cancels the Layering Orders
02 Spoofing For purposes of this Rule spoofing activity shall include a frequent pattern in which the following facts are present
(a) a party narrows the spread fo r a security by placing an order inside the NBBO (the Spoofing Order) and
(b) the party then submits an order on the opposite side of the market (Contra-Side Order) that executes against another market
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participant that joined the new inside market established by the Spoofing Order
03 Applicability For purposes of this Rule layering activity and spoofing activity shall include a frequent pattern in which the facts listed above are present Unless otherwise indicated the order of the events indicating the pattern does not modify the applicability of the Rule Further layering activity and spoofing activity includes a pattern or practice in which all of the layering or spoofing activity is conducted on the Exchange as well as a pattern or practice in which some portion of the layering or spoofing activity is conducted on the Exchange and the other portions of the layering or spoofing activity is conducted on one or more other exchanges
Essentially proposed Rule 81 7 provides an expedited suspension hearing process to remedy violations of proposed Rule 12 15 A Member vho is accused of a violation or hose client is accused of a violation (Subject Member) is provided notice requesting that the Subject Member either take action or refrain from action and a detailed statement of facts to support the allegations of a violation of Rule 12 15 signed by a person with knowledge of the factual allegations Rule 817 then provides for the expedited appointment of a hearing panel and a procedure by which the Subject Member may move to disqualify a member of the hearing panel The Subject Member then must be served with a notice of hearing not later than 7 days before the hearing The hearing shall take place not less than 15 days after the initiation of suspension proceedings under Rule 817 After the hearing the hearing panel must issue a written decision stating whether a suspens ion order shall be imposed not later than I 0 days after the panel receives the hearing transcript Under Rule 81 7 a suspension order shall be imposed if the Hearing Panel finds
(A) by a preponderance of the evidence that the alleged violation specified in the notice has occurred and
(B) that the violative conduct or continuation thereof is likely to result in significant market disruption or other significant harm to investors
lf the hearing panel imposes a suspension order the order shall (1 ) set forth the alleged violati on and the significant market disrnption or other significant harm to investors that is likely to result middotVithout the issuance of an order (2) describe in reasonable detail the act or acts the Subject Member is to take or refrain from taking and (3) include the date and hour of the orders issuance A suspension order under Rule 8 17 shall be limited to orderi ng the Subject Member cease and desist from violating Rule 12 15 andor providing access to the Exchange to a client of the Subject Member that is causing violations o f Rule 1215 The Initial Proposal also provides sanctions for the Subject Members violation of a suspension order
The Initial Proposal provides that any sanction imposed pmsuant to proposed Rule 817 is final and immediately effective The proposed Rule dictates that the filing of an application for
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review with the SEC does not stay any sanction imposed under the rule unless the SEC orders otherwise Finally the proposed Rule permits the Subject Member who is served with a suspension order to apply to the Hearing Panel to request the order be modified set aside limited or revoked The Hearing Panel must provide an expedited response to the application within ten days
C Withdrawal and Revision of the initial Proposal
After review and consideration of comments from the public the Exchange has Vithdrawn the Initial Proposal and refiled the Revised Proposal The Revised Proposal modifies Rule 12 15 to replace the terms Layering and Spoofing with the terms Disruptive Quoting and Trading Activity Type l and Disruptive Quoting and Trading Act ivity Type 2 respectively The Revised Proposal also updates the terminology in Rules 8 17 and 12 1 5 to reflect the revised terminology of Rule 1215
In the Revised Proposal the Exchange a lso removes subparagraph ( f) of proposed Rule 8 17 contained in the Initial Proposal Subparagraph (f) provided a process for sanctioning violations of a suspension order It is the Exchanges position that a suspension order issued under Rule 8 17 is enforceable against the Subject Member and no additional process is required to discipline the violation of an order thereby making subparagraph (f) of proposed Rule 8 I 7 in the Initial Proposal superfluous
Finally the Revised proposal modifies subparagraph (d)(2)(A) of proposed Rule 81 7 to clarify that a suspension order is to order that a Member served vi th such order is suspended from access to the Exchange unless and until the Member complies with the cease and desist provisions of the order
II Conunent Letters and Response
Five Comment Letters were submitted to the SEC by four different commenters in response to the Initial Proposal Sec Letters from Samuel F Lek Chief Executive Officer Lek Securities Corporation dated September 3 2015 and September 18 201 5 (Lek Letters) Letter fro m RT Leuchtkafer dated September 4 201 5 (Leuchtkafer Letter) Letter from Mary Ami Burns Chief Operating Officer FIA Principal Traders Group dated September 9 20 I 5 ( FTA PTO Letter) and Comment from Teresa B Machado dated August 19 201 5 (Machado Comment) (co llectively the Comment Letters) The Exchange appreciates the FTA PTO Letters support of the Exchanges objecti ves and appreciates the specific concerns rai sed in the FIA PTO Letter Further the Exchange appreciates the Lek Letters and the Leuchtkafer Letters respective critiques of the Initial Proposal The Exchange also appreciates the Machado Comment s support of the Initial Proposal The Exchange responds belo to the concerns and criti cisms raised in the Comment Letters
A Definitions of Layering and Spoofing Contained in Proposed Rule 12 15
The Lek Letters raise the concern that the definitions of Layering and Spoofing in Proposed Rule I 2 15 are too broad encompassing activities that are not manipulative and
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accordingly do not violate the anti-fraud provisions of the securities laws6 The FIA PTG Letter raises the concern that the definitions of Layering and Spoofing in the Initial Proposal are overbroad and may wrongly penalize legitimate good faith actions7 Specifically the FIA PTG Letter takes issue with the lack of an express intent element in the definition of Layering and Spoofing8
On the other hand the Leuchtkafer Letter asserts that the proposed definitions of Layering and Spoofing are much too narrow9 The Leuchtkafer Letter asserts that the Proposed Rule defines Layering and Spoofing as very certain kind[ s] of act[ s] apparently exclusive of any other act[s] 10 The Leuchtkafer Letter is concerned that the proposed definitions will insulate from enforcement manipulative acts that do not fall tidily within those definitions11
The Exchange agrees that the harmful practices of layering and spoofing are defined by an intent element Indeed intent is often what distinguishes manipulative fraudulent practices from legitimate good faith behavior The Exchange acknowledged this in the Initial Proposal Proposed Rule 1215 includes an intent element by defining the respective disrnptive quoting and trading activities as a frequent pattern of the enumerated conduct Such a frequent pattern evidences manipulative intent 12
6 See September 3 2015 Lek Letter 1 The Lek Letters also lodge an array of semantic arguments against the proposed rule The Lek Letters argue that the rule is impermissibly vague because it uses the terms frequent pattern and multiple without further definition It is the Exchanges position that these terms are generally understood by their plain and ordinary meanings and therefore adequately describe the proscribed conduct
7 FIA PTG Letter 3-4 s FIA PTG Letter 3 The Lek Letters also argue that because layered orders could
theoretically be executed a trader engaged in layering could not possibly intend the orders not be executed even if he hopes that the orders do not execute September 3 2015 Lek Letter 4 This is a logical fallacy akin to arguing that a murderer did not intend to kill because although he hoped that the bullet he aimed and fired would kill his victim it was possible the bullet could miss The ultimate result of an act is not determinative of intent Neither are the possible results Instead intent is a mental slate that must exist at the time of the act in question
9 Leuchtkafer Letter 1 JO Id at 2
II Id at 3 12 The Exchange has observed that the frequent pattern of the proscribed activities is
typically the key indication of intent in layering and spoofing cases While additional corroborating information is sometimes considered to prove intent - such as contemporaneous communications or party testimony - in the Exchanges experience that
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The Leuchtkafer Letters concern that the definition of certain practices as Layering and Spoofing could be read to exclude other layering and spoofing practices is also well-taken The purpose or proposed Rule 12 15 however is not to provide universal definitions of layering and spoofing Rather once certain obvious and uncomplicated cases of disruptive and manipulative behavior or particularly harmful behavior has been identified the purpose of the proposed Rule is to initiate an expedited suspension proceeding in order to stop the behavior from continuing on the Exchange if a Member is engaging in or facilitating layering or spoofing activity and the Member has received sufficient notice vith an opportunity to respond but such activity has not ceased13 The Exchange has identified certain patterns and practices that are hallmarks of the most egregious spoofing andor layering conduct In the initial proposed Rule 12 15 the Exchange defined this conduct as Spoofing and Layering
But as discussed by the FIA PTO Letter and the Lek Letters non-spoofing and nonshylayering activity could conceivably fall within the definitions of Layering and Spoofing in the Initial Proposal and as pointed out by the Leuchtkafer Letter manipulative layering and spoofing activity could conceivably fall outside the proposed definitions Since the purpose of proposed Rules 87 and 1215 is not to provide a precise definition of layering and spoofing but to protect market participants from the harm caused by a Subject Members refusal to cease obvious disruptive market practices the Exchange has modified the defined terms in proposed Rule 1215 in the Revised Proposal The defined term Layering in initial Proposed Rule 12 15 is now labeled Disruptive Quoting and Trading Activity Type l The defined term Spoofing in the initial Proposed Rule is now labeled Disruptive Quoting and Trading Activity Type 2
The Exchange believes this change in terminology advances the objective to protect market participants from harmful manipulative behavior while alleviating both the concern that the definitions of Layering and Spoofing could insulate undefined manipulative conduct and the concern that the Proposed Rule would give the Exchange the ability to prove Layering and Spoofing v1ithout expressly proving intent This change in terminology - paired middotwith the expedited suspension order review application process - highlights that the proposed Rule 817 is a market protection rule designed to halt a very specific readily identifiable type of illegal
information typically serves only to confirm the manipulative intent indicated by a repeated pattern of disruptive activity While this corroboration Viii sti ll be obtained where available in an ultimate enfo rcement action the Exchange believes that it is unacceptable for the market to cont inue to be harmed during the time between the initial identification of manipulative intent from a frequent pattern of manipulative conduct and the discovery of corroborat ing evidence of that manipulative intent At the same time the Exchange believes that some indication of intent must exist to take action under the proposed Rules The Exchange therefore proposes to balance these competing interests by requiring a showing or a frequent pattern of disruptive activity - the most prominent badge of intent - before a suspension order may issue
See Initial Proposal Amendment No I at 5037 1
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trading activity rather than an attempt to define and punish layering and spoofing in every conceivable context 14
B Process ofExpedited Client Smpension Hearing Proceeding
Proposed Rule 817 provides a mechanism to swiHly halt egregious manipulative trading activity by Members andor clients of Members that ignore the Exchanges requests to cease the manipulative practices The Proposal provides an innovative mechanism to protect market participants from rogue clients andor Members who heretofore have been free to continue their manipulative activities pending the investigation and enforcement of their violations
The Lek Letters raise concerns regarding the expedited process for the proposed suspension proceedings15 The Lek Letters argue that the Exchange has no authority to enact the proposed Rule because the Exchange does not have jurisdiction over the clients of Members of the Exchange and that the proposed proceeding does not provide due process to a Members client that is the subject of a suspension order 16 Finally the Lek Letters argue that the proposed Expedited Client Suspension Hearing is a summary proceeding that violates the Act 17 The FIA PTO Letter on the other hand believes the Exchange s investigation notice and hearing processes described in connection with proposed Rule 817 are reasonable but suggests the process described in the Initial Proposal should be provided in an alternative format - eg as part of the proposed Rules as interpretive guidance or as FAQs 18
1 The Exchange Has Jurisdiction Over Its Members for Misconduct of a Members Client
The Lek Letters argument that the Exchange lacks jurisdiction to remedy a Members clients misconduct is mistaken As a condition of Exchange access Rule I l 3(a) requires a Member to agree to the Exchanges User Agreement which states
Except as otherwise provided herein with respect to all orders submitted to Exchange by User it is the sole responsibility of User to ensure compliance by itself its customers and its representatives with all applicable United States federal and state laws rules and regulations as well as those of FIN RA or any
14 lt is the Exchanges position that layering and spoofing are already prohibited illegal practices and at this time it is not necessary to separately define those already illegal practices See 17 CFR 240 1 Ob-5 Rule 12 1 Rule 122 The Exchange of course will revisit the issue if the need arises to specifically define layering and spoofing beyond the current generally accepted definitions of the prohibited illegal practices
15 September 3 2015 Lek Letter 5
16 kl 17 kl 18 FIA PTO Letter 2
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other self-regulatory organization of which the User is a member to the extent applicable to User User represents and warrants that it is and will remain responsible for its use of Exchange and the use of Exchange by any of its employees customers or agents or if User is a member of Exchange by any person vhich has entered into a sponsorship arrangement vith User to use Exchange (a Sponsored Participant)
Under the Exchange Rules and the User Agreement therefore a Members clients violation of the Act andor the Rules is charged to the Member
Rule 81 confers jurisdiction to the Exchange over [a] Member who is alleged to have violated or aided and abetted a violation of any provision of the Act or the rules and regulations promulgated thereunder or any provision of the Certificate oflncorporation By-Laws or Rules of the Exchange or any interpretation thereof or any resolution or order of the Board or appropriate Exchange committee The Exchange Rules therefore unquestionably confer jurisdiction to the Exchange to discipline its Members for a Members client s violations of the Act and the Exchanges Rules This jurisdiction over a Member for a clients actions is not only permissible - it is essential for the effective regulation of the Exchange 19 Because the Exchange has jurisdiction over a Member for the Members client s violations the Exchange has jurisdiction to enforce proposed Rule 817
The Lek Letters concern regarding the alleged lack of process provided to a Subject Members client is similarly misguided Because the Subject Member has ultimate responsibility for its clients actions and because proposed Rule 817 imposes discipline against the Subject Member - not the client - for the clients violations due process to the Subject Member is sufficient While the Exchange recognizes that the client may be adversely affected by the discipline against the Subject Member there is nothing in the proposed Rules that prevents a Subject Members client from participating in an expedited suspension hearing To the contrary the Exchange Velcomes the participation of the client at the hearing Because the suspension order is entered against the Subject Member however and not the client there is no due process that must be afforded the Subject Member s client
2 The Expedited Client Suspension Hearing Provides Due Process Under the Act to the Subject Member
The Lek Letters assert that the proposed expedited client suspension hearing would violate the Act because it is a summary proceeding not authorized by Section 6(d)(3) of the Act This assertion is incorrect because the proposed expedited client suspension proceeding is not a summary proceeding under Section 6(d)(3)
The Lek Letters assertion that the Exchange has no jurisdiction over a Member for a Members clients conduct would leave the Exchange helpless to enforce its own rules unless the member voluntarily cooperates with the enforcement process Such a result is obviously untenable and fli es in the face of the Exchanges obligation to enforce securities laws under the Act
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The suspension by summary proceeding permitted by Section 6(d)(3) is imposed prior to notice to the Member and an opportunity to be heard20 In contrast the proposed expedited client suspension hearing is governed by Section 6(d)(2) which provides the process for determining whether a person shall be denied membership barred from becoming associated with a member or prohibited or limited with respect to access to services offered by the exchange or a member thereof 21 As required by Section 6(d)(2) the proposed expedited client suspension hearing notif[ies] such person of and give[s] him an opportunity to be heard upon the specific grounds for denial bar or prohibition or limitation under consideration and keep[s] a record22 The expedited client suspension hearing proceeding therefore provides the clue process required under the Act
The Lek Letters also complain that the proposed expedited client suspension hearing proceeding is unfair because it does not provide sufficient time for discovery after the Exchange initiates the process As detailed in the Initial Proposal hovever the Exchange only intends to initiate the expedited client suspension hearing proceeding after an initial investigation and after the Exchange contacts the Member responsible for the orders to request an explanation of the activity and any additional relevant information Further the investigation and enforcement proceeding do not terminate upon the entry of a suspension order Discovery 1ill proceed as it would during any other enforcement action lf during the discovery process a Subject Member discovers information it believes to be exculpatory the proposed Rule allows a Subject Member [a]t any time after the [Subject Member] is served with a suspension order to apply to the Hearing Panel to have the order modified set aside limited or revoked Proposed Rule 817 merely places the burden on the Subject Member to show that it has halted its harmful practice or its clients harmful practice before being permitted to resume activity on the Exchange rather than requiring the market to bear the harm of manipulative conduct during the time-consuming discovery process Proposed Rule 817 therefore is not unfair - it is indeed fairer because it imposes the consequences of a Subject Member s harmful conduct on the Subject Member rather than imposing those consequences on the entire market
3 The Initial Proposal Clearly Defines the Parameters of Use of Proposed Rule 817
The Initial Proposal and Revised Proposal acknOmiddotVledge that the formidable power and discretion provided by proposed Rule 817 must be exercised only in the most egregious cases after a Subject Member has been given ample notice and opportunity to cease and desist the manipulative practices prohibited by the proposed Rule While the FIA PTO Letter suggests the Exchange include the process in other places the Exchange believes that the process of proposed Rule 817 and its proposed circumstances of use are clearly detailed in the Revised Proposal and would not be further clarified by repetition
20 15 USC 78f(d)(3)
21 lei at 78f( d)(2)
22 Id
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C Layering and Spoltfing Are Fraudulent Manipulative and Illegal Prnclices
Although many of the issues raised by the Lek Letters address the proposed definition of Layering and Spoofing in the Initial Proposal much of the Lek Letters argument appears to challenge the existing prohibitions in the Act against the manipulative and deceptive practices of layering and spoofing23 In fact the Lek Letters go so far as to argue that a prohibition of layering and spoofing would violate Section 6(b)(5) of the Act24
As layering and spoofing are fraudulent and manipulative practices prohibited by the Act the proposed Rules prohibiting those practices comports with Section 6(b)(5) and advances the Acts purposes Further the proposed Rules are neither anticompetitive nor unfairly discriminatory in violation of the Act as it only disciplines prohibited illegal behavior Proposed Rules 817 and I 2 I 5 therefore are consistent with the Act
III Conclusion
For the foregoing reasons the Exchange respectfully requests the Commission approve the Revised Proposal
Very truly yours
~ Anders Franzon VP Associate General Counsel
cc Stephen Luparello Director Division of Trading amp Markets David Shillman Associate Director Division ofTrading amp Markets David Liu Senior Special Counsel Division of Trading amp Markets
23 See 17 CFR 240 I Ob-5 Rule 121 Rule 122 24 September 3 2015 Lek Letter 3-6
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B The initial Proposal
In the Initial Proposal the Exchange proposed to adopt nevl Rule 817 to establish expedited procedures for issuing suspension orders immediately prohibiting a Member from conducting continued layering or spoofing activity on the Exchange and establishing the procedures to permit the Exchange to order a Member cease and desist providing a client of the Member access to the Exchange when the client of the Member is conducting layering or spoofing activity in violation of proposed Rule 1215 The definit ions of prohibited Layering and Spoofing contained in Rule 1215 are designed to encompass conduct the Exchange has observed in the most egregious layering and spoofing cases Proposed Rule 1215 prohibits Layering and Spoofing as follows
12 15 Layering and Spoofing Prohibited
No member shall engage in or facilitate layering or spoofing activity on the Exchange as described in Interpretation and Policy 0 I of this Rule includ ing acting in concert vvith other persons to effect such activity
interpretations and Policies
0 I Layering For purposes of this Rule layering activity shall include a frequent pattern in which the following facts are present
(a) a party enters multiple limit orders on one side o f the market at various price levels (the Layering Orders) and
(b) fol lowing the entry or the Layering Orders the level of supply and demand for the security changes and
(c) the party enters one or more orders on the opposite side of the market o f the Layering Orders (the Contra-Side Orders) that are subsequently executed and
(d) follmving the execution of the Contra-Side Orders the party cancels the Layering Orders
02 Spoofing For purposes of this Rule spoofing activity shall include a frequent pattern in which the following facts are present
(a) a party narrows the spread fo r a security by placing an order inside the NBBO (the Spoofing Order) and
(b) the party then submits an order on the opposite side of the market (Contra-Side Order) that executes against another market
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participant that joined the new inside market established by the Spoofing Order
03 Applicability For purposes of this Rule layering activity and spoofing activity shall include a frequent pattern in which the facts listed above are present Unless otherwise indicated the order of the events indicating the pattern does not modify the applicability of the Rule Further layering activity and spoofing activity includes a pattern or practice in which all of the layering or spoofing activity is conducted on the Exchange as well as a pattern or practice in which some portion of the layering or spoofing activity is conducted on the Exchange and the other portions of the layering or spoofing activity is conducted on one or more other exchanges
Essentially proposed Rule 81 7 provides an expedited suspension hearing process to remedy violations of proposed Rule 12 15 A Member vho is accused of a violation or hose client is accused of a violation (Subject Member) is provided notice requesting that the Subject Member either take action or refrain from action and a detailed statement of facts to support the allegations of a violation of Rule 12 15 signed by a person with knowledge of the factual allegations Rule 817 then provides for the expedited appointment of a hearing panel and a procedure by which the Subject Member may move to disqualify a member of the hearing panel The Subject Member then must be served with a notice of hearing not later than 7 days before the hearing The hearing shall take place not less than 15 days after the initiation of suspension proceedings under Rule 817 After the hearing the hearing panel must issue a written decision stating whether a suspens ion order shall be imposed not later than I 0 days after the panel receives the hearing transcript Under Rule 81 7 a suspension order shall be imposed if the Hearing Panel finds
(A) by a preponderance of the evidence that the alleged violation specified in the notice has occurred and
(B) that the violative conduct or continuation thereof is likely to result in significant market disruption or other significant harm to investors
lf the hearing panel imposes a suspension order the order shall (1 ) set forth the alleged violati on and the significant market disrnption or other significant harm to investors that is likely to result middotVithout the issuance of an order (2) describe in reasonable detail the act or acts the Subject Member is to take or refrain from taking and (3) include the date and hour of the orders issuance A suspension order under Rule 8 17 shall be limited to orderi ng the Subject Member cease and desist from violating Rule 12 15 andor providing access to the Exchange to a client of the Subject Member that is causing violations o f Rule 1215 The Initial Proposal also provides sanctions for the Subject Members violation of a suspension order
The Initial Proposal provides that any sanction imposed pmsuant to proposed Rule 817 is final and immediately effective The proposed Rule dictates that the filing of an application for
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review with the SEC does not stay any sanction imposed under the rule unless the SEC orders otherwise Finally the proposed Rule permits the Subject Member who is served with a suspension order to apply to the Hearing Panel to request the order be modified set aside limited or revoked The Hearing Panel must provide an expedited response to the application within ten days
C Withdrawal and Revision of the initial Proposal
After review and consideration of comments from the public the Exchange has Vithdrawn the Initial Proposal and refiled the Revised Proposal The Revised Proposal modifies Rule 12 15 to replace the terms Layering and Spoofing with the terms Disruptive Quoting and Trading Activity Type l and Disruptive Quoting and Trading Act ivity Type 2 respectively The Revised Proposal also updates the terminology in Rules 8 17 and 12 1 5 to reflect the revised terminology of Rule 1215
In the Revised Proposal the Exchange a lso removes subparagraph ( f) of proposed Rule 8 17 contained in the Initial Proposal Subparagraph (f) provided a process for sanctioning violations of a suspension order It is the Exchanges position that a suspension order issued under Rule 8 17 is enforceable against the Subject Member and no additional process is required to discipline the violation of an order thereby making subparagraph (f) of proposed Rule 8 I 7 in the Initial Proposal superfluous
Finally the Revised proposal modifies subparagraph (d)(2)(A) of proposed Rule 81 7 to clarify that a suspension order is to order that a Member served vi th such order is suspended from access to the Exchange unless and until the Member complies with the cease and desist provisions of the order
II Conunent Letters and Response
Five Comment Letters were submitted to the SEC by four different commenters in response to the Initial Proposal Sec Letters from Samuel F Lek Chief Executive Officer Lek Securities Corporation dated September 3 2015 and September 18 201 5 (Lek Letters) Letter fro m RT Leuchtkafer dated September 4 201 5 (Leuchtkafer Letter) Letter from Mary Ami Burns Chief Operating Officer FIA Principal Traders Group dated September 9 20 I 5 ( FTA PTO Letter) and Comment from Teresa B Machado dated August 19 201 5 (Machado Comment) (co llectively the Comment Letters) The Exchange appreciates the FTA PTO Letters support of the Exchanges objecti ves and appreciates the specific concerns rai sed in the FIA PTO Letter Further the Exchange appreciates the Lek Letters and the Leuchtkafer Letters respective critiques of the Initial Proposal The Exchange also appreciates the Machado Comment s support of the Initial Proposal The Exchange responds belo to the concerns and criti cisms raised in the Comment Letters
A Definitions of Layering and Spoofing Contained in Proposed Rule 12 15
The Lek Letters raise the concern that the definitions of Layering and Spoofing in Proposed Rule I 2 15 are too broad encompassing activities that are not manipulative and
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accordingly do not violate the anti-fraud provisions of the securities laws6 The FIA PTG Letter raises the concern that the definitions of Layering and Spoofing in the Initial Proposal are overbroad and may wrongly penalize legitimate good faith actions7 Specifically the FIA PTG Letter takes issue with the lack of an express intent element in the definition of Layering and Spoofing8
On the other hand the Leuchtkafer Letter asserts that the proposed definitions of Layering and Spoofing are much too narrow9 The Leuchtkafer Letter asserts that the Proposed Rule defines Layering and Spoofing as very certain kind[ s] of act[ s] apparently exclusive of any other act[s] 10 The Leuchtkafer Letter is concerned that the proposed definitions will insulate from enforcement manipulative acts that do not fall tidily within those definitions11
The Exchange agrees that the harmful practices of layering and spoofing are defined by an intent element Indeed intent is often what distinguishes manipulative fraudulent practices from legitimate good faith behavior The Exchange acknowledged this in the Initial Proposal Proposed Rule 1215 includes an intent element by defining the respective disrnptive quoting and trading activities as a frequent pattern of the enumerated conduct Such a frequent pattern evidences manipulative intent 12
6 See September 3 2015 Lek Letter 1 The Lek Letters also lodge an array of semantic arguments against the proposed rule The Lek Letters argue that the rule is impermissibly vague because it uses the terms frequent pattern and multiple without further definition It is the Exchanges position that these terms are generally understood by their plain and ordinary meanings and therefore adequately describe the proscribed conduct
7 FIA PTG Letter 3-4 s FIA PTG Letter 3 The Lek Letters also argue that because layered orders could
theoretically be executed a trader engaged in layering could not possibly intend the orders not be executed even if he hopes that the orders do not execute September 3 2015 Lek Letter 4 This is a logical fallacy akin to arguing that a murderer did not intend to kill because although he hoped that the bullet he aimed and fired would kill his victim it was possible the bullet could miss The ultimate result of an act is not determinative of intent Neither are the possible results Instead intent is a mental slate that must exist at the time of the act in question
9 Leuchtkafer Letter 1 JO Id at 2
II Id at 3 12 The Exchange has observed that the frequent pattern of the proscribed activities is
typically the key indication of intent in layering and spoofing cases While additional corroborating information is sometimes considered to prove intent - such as contemporaneous communications or party testimony - in the Exchanges experience that
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The Leuchtkafer Letters concern that the definition of certain practices as Layering and Spoofing could be read to exclude other layering and spoofing practices is also well-taken The purpose or proposed Rule 12 15 however is not to provide universal definitions of layering and spoofing Rather once certain obvious and uncomplicated cases of disruptive and manipulative behavior or particularly harmful behavior has been identified the purpose of the proposed Rule is to initiate an expedited suspension proceeding in order to stop the behavior from continuing on the Exchange if a Member is engaging in or facilitating layering or spoofing activity and the Member has received sufficient notice vith an opportunity to respond but such activity has not ceased13 The Exchange has identified certain patterns and practices that are hallmarks of the most egregious spoofing andor layering conduct In the initial proposed Rule 12 15 the Exchange defined this conduct as Spoofing and Layering
But as discussed by the FIA PTO Letter and the Lek Letters non-spoofing and nonshylayering activity could conceivably fall within the definitions of Layering and Spoofing in the Initial Proposal and as pointed out by the Leuchtkafer Letter manipulative layering and spoofing activity could conceivably fall outside the proposed definitions Since the purpose of proposed Rules 87 and 1215 is not to provide a precise definition of layering and spoofing but to protect market participants from the harm caused by a Subject Members refusal to cease obvious disruptive market practices the Exchange has modified the defined terms in proposed Rule 1215 in the Revised Proposal The defined term Layering in initial Proposed Rule 12 15 is now labeled Disruptive Quoting and Trading Activity Type l The defined term Spoofing in the initial Proposed Rule is now labeled Disruptive Quoting and Trading Activity Type 2
The Exchange believes this change in terminology advances the objective to protect market participants from harmful manipulative behavior while alleviating both the concern that the definitions of Layering and Spoofing could insulate undefined manipulative conduct and the concern that the Proposed Rule would give the Exchange the ability to prove Layering and Spoofing v1ithout expressly proving intent This change in terminology - paired middotwith the expedited suspension order review application process - highlights that the proposed Rule 817 is a market protection rule designed to halt a very specific readily identifiable type of illegal
information typically serves only to confirm the manipulative intent indicated by a repeated pattern of disruptive activity While this corroboration Viii sti ll be obtained where available in an ultimate enfo rcement action the Exchange believes that it is unacceptable for the market to cont inue to be harmed during the time between the initial identification of manipulative intent from a frequent pattern of manipulative conduct and the discovery of corroborat ing evidence of that manipulative intent At the same time the Exchange believes that some indication of intent must exist to take action under the proposed Rules The Exchange therefore proposes to balance these competing interests by requiring a showing or a frequent pattern of disruptive activity - the most prominent badge of intent - before a suspension order may issue
See Initial Proposal Amendment No I at 5037 1
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trading activity rather than an attempt to define and punish layering and spoofing in every conceivable context 14
B Process ofExpedited Client Smpension Hearing Proceeding
Proposed Rule 817 provides a mechanism to swiHly halt egregious manipulative trading activity by Members andor clients of Members that ignore the Exchanges requests to cease the manipulative practices The Proposal provides an innovative mechanism to protect market participants from rogue clients andor Members who heretofore have been free to continue their manipulative activities pending the investigation and enforcement of their violations
The Lek Letters raise concerns regarding the expedited process for the proposed suspension proceedings15 The Lek Letters argue that the Exchange has no authority to enact the proposed Rule because the Exchange does not have jurisdiction over the clients of Members of the Exchange and that the proposed proceeding does not provide due process to a Members client that is the subject of a suspension order 16 Finally the Lek Letters argue that the proposed Expedited Client Suspension Hearing is a summary proceeding that violates the Act 17 The FIA PTO Letter on the other hand believes the Exchange s investigation notice and hearing processes described in connection with proposed Rule 817 are reasonable but suggests the process described in the Initial Proposal should be provided in an alternative format - eg as part of the proposed Rules as interpretive guidance or as FAQs 18
1 The Exchange Has Jurisdiction Over Its Members for Misconduct of a Members Client
The Lek Letters argument that the Exchange lacks jurisdiction to remedy a Members clients misconduct is mistaken As a condition of Exchange access Rule I l 3(a) requires a Member to agree to the Exchanges User Agreement which states
Except as otherwise provided herein with respect to all orders submitted to Exchange by User it is the sole responsibility of User to ensure compliance by itself its customers and its representatives with all applicable United States federal and state laws rules and regulations as well as those of FIN RA or any
14 lt is the Exchanges position that layering and spoofing are already prohibited illegal practices and at this time it is not necessary to separately define those already illegal practices See 17 CFR 240 1 Ob-5 Rule 12 1 Rule 122 The Exchange of course will revisit the issue if the need arises to specifically define layering and spoofing beyond the current generally accepted definitions of the prohibited illegal practices
15 September 3 2015 Lek Letter 5
16 kl 17 kl 18 FIA PTO Letter 2
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other self-regulatory organization of which the User is a member to the extent applicable to User User represents and warrants that it is and will remain responsible for its use of Exchange and the use of Exchange by any of its employees customers or agents or if User is a member of Exchange by any person vhich has entered into a sponsorship arrangement vith User to use Exchange (a Sponsored Participant)
Under the Exchange Rules and the User Agreement therefore a Members clients violation of the Act andor the Rules is charged to the Member
Rule 81 confers jurisdiction to the Exchange over [a] Member who is alleged to have violated or aided and abetted a violation of any provision of the Act or the rules and regulations promulgated thereunder or any provision of the Certificate oflncorporation By-Laws or Rules of the Exchange or any interpretation thereof or any resolution or order of the Board or appropriate Exchange committee The Exchange Rules therefore unquestionably confer jurisdiction to the Exchange to discipline its Members for a Members client s violations of the Act and the Exchanges Rules This jurisdiction over a Member for a clients actions is not only permissible - it is essential for the effective regulation of the Exchange 19 Because the Exchange has jurisdiction over a Member for the Members client s violations the Exchange has jurisdiction to enforce proposed Rule 817
The Lek Letters concern regarding the alleged lack of process provided to a Subject Members client is similarly misguided Because the Subject Member has ultimate responsibility for its clients actions and because proposed Rule 817 imposes discipline against the Subject Member - not the client - for the clients violations due process to the Subject Member is sufficient While the Exchange recognizes that the client may be adversely affected by the discipline against the Subject Member there is nothing in the proposed Rules that prevents a Subject Members client from participating in an expedited suspension hearing To the contrary the Exchange Velcomes the participation of the client at the hearing Because the suspension order is entered against the Subject Member however and not the client there is no due process that must be afforded the Subject Member s client
2 The Expedited Client Suspension Hearing Provides Due Process Under the Act to the Subject Member
The Lek Letters assert that the proposed expedited client suspension hearing would violate the Act because it is a summary proceeding not authorized by Section 6(d)(3) of the Act This assertion is incorrect because the proposed expedited client suspension proceeding is not a summary proceeding under Section 6(d)(3)
The Lek Letters assertion that the Exchange has no jurisdiction over a Member for a Members clients conduct would leave the Exchange helpless to enforce its own rules unless the member voluntarily cooperates with the enforcement process Such a result is obviously untenable and fli es in the face of the Exchanges obligation to enforce securities laws under the Act
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The suspension by summary proceeding permitted by Section 6(d)(3) is imposed prior to notice to the Member and an opportunity to be heard20 In contrast the proposed expedited client suspension hearing is governed by Section 6(d)(2) which provides the process for determining whether a person shall be denied membership barred from becoming associated with a member or prohibited or limited with respect to access to services offered by the exchange or a member thereof 21 As required by Section 6(d)(2) the proposed expedited client suspension hearing notif[ies] such person of and give[s] him an opportunity to be heard upon the specific grounds for denial bar or prohibition or limitation under consideration and keep[s] a record22 The expedited client suspension hearing proceeding therefore provides the clue process required under the Act
The Lek Letters also complain that the proposed expedited client suspension hearing proceeding is unfair because it does not provide sufficient time for discovery after the Exchange initiates the process As detailed in the Initial Proposal hovever the Exchange only intends to initiate the expedited client suspension hearing proceeding after an initial investigation and after the Exchange contacts the Member responsible for the orders to request an explanation of the activity and any additional relevant information Further the investigation and enforcement proceeding do not terminate upon the entry of a suspension order Discovery 1ill proceed as it would during any other enforcement action lf during the discovery process a Subject Member discovers information it believes to be exculpatory the proposed Rule allows a Subject Member [a]t any time after the [Subject Member] is served with a suspension order to apply to the Hearing Panel to have the order modified set aside limited or revoked Proposed Rule 817 merely places the burden on the Subject Member to show that it has halted its harmful practice or its clients harmful practice before being permitted to resume activity on the Exchange rather than requiring the market to bear the harm of manipulative conduct during the time-consuming discovery process Proposed Rule 817 therefore is not unfair - it is indeed fairer because it imposes the consequences of a Subject Member s harmful conduct on the Subject Member rather than imposing those consequences on the entire market
3 The Initial Proposal Clearly Defines the Parameters of Use of Proposed Rule 817
The Initial Proposal and Revised Proposal acknOmiddotVledge that the formidable power and discretion provided by proposed Rule 817 must be exercised only in the most egregious cases after a Subject Member has been given ample notice and opportunity to cease and desist the manipulative practices prohibited by the proposed Rule While the FIA PTO Letter suggests the Exchange include the process in other places the Exchange believes that the process of proposed Rule 817 and its proposed circumstances of use are clearly detailed in the Revised Proposal and would not be further clarified by repetition
20 15 USC 78f(d)(3)
21 lei at 78f( d)(2)
22 Id
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C Layering and Spoltfing Are Fraudulent Manipulative and Illegal Prnclices
Although many of the issues raised by the Lek Letters address the proposed definition of Layering and Spoofing in the Initial Proposal much of the Lek Letters argument appears to challenge the existing prohibitions in the Act against the manipulative and deceptive practices of layering and spoofing23 In fact the Lek Letters go so far as to argue that a prohibition of layering and spoofing would violate Section 6(b)(5) of the Act24
As layering and spoofing are fraudulent and manipulative practices prohibited by the Act the proposed Rules prohibiting those practices comports with Section 6(b)(5) and advances the Acts purposes Further the proposed Rules are neither anticompetitive nor unfairly discriminatory in violation of the Act as it only disciplines prohibited illegal behavior Proposed Rules 817 and I 2 I 5 therefore are consistent with the Act
III Conclusion
For the foregoing reasons the Exchange respectfully requests the Commission approve the Revised Proposal
Very truly yours
~ Anders Franzon VP Associate General Counsel
cc Stephen Luparello Director Division of Trading amp Markets David Shillman Associate Director Division ofTrading amp Markets David Liu Senior Special Counsel Division of Trading amp Markets
23 See 17 CFR 240 I Ob-5 Rule 121 Rule 122 24 September 3 2015 Lek Letter 3-6
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participant that joined the new inside market established by the Spoofing Order
03 Applicability For purposes of this Rule layering activity and spoofing activity shall include a frequent pattern in which the facts listed above are present Unless otherwise indicated the order of the events indicating the pattern does not modify the applicability of the Rule Further layering activity and spoofing activity includes a pattern or practice in which all of the layering or spoofing activity is conducted on the Exchange as well as a pattern or practice in which some portion of the layering or spoofing activity is conducted on the Exchange and the other portions of the layering or spoofing activity is conducted on one or more other exchanges
Essentially proposed Rule 81 7 provides an expedited suspension hearing process to remedy violations of proposed Rule 12 15 A Member vho is accused of a violation or hose client is accused of a violation (Subject Member) is provided notice requesting that the Subject Member either take action or refrain from action and a detailed statement of facts to support the allegations of a violation of Rule 12 15 signed by a person with knowledge of the factual allegations Rule 817 then provides for the expedited appointment of a hearing panel and a procedure by which the Subject Member may move to disqualify a member of the hearing panel The Subject Member then must be served with a notice of hearing not later than 7 days before the hearing The hearing shall take place not less than 15 days after the initiation of suspension proceedings under Rule 817 After the hearing the hearing panel must issue a written decision stating whether a suspens ion order shall be imposed not later than I 0 days after the panel receives the hearing transcript Under Rule 81 7 a suspension order shall be imposed if the Hearing Panel finds
(A) by a preponderance of the evidence that the alleged violation specified in the notice has occurred and
(B) that the violative conduct or continuation thereof is likely to result in significant market disruption or other significant harm to investors
lf the hearing panel imposes a suspension order the order shall (1 ) set forth the alleged violati on and the significant market disrnption or other significant harm to investors that is likely to result middotVithout the issuance of an order (2) describe in reasonable detail the act or acts the Subject Member is to take or refrain from taking and (3) include the date and hour of the orders issuance A suspension order under Rule 8 17 shall be limited to orderi ng the Subject Member cease and desist from violating Rule 12 15 andor providing access to the Exchange to a client of the Subject Member that is causing violations o f Rule 1215 The Initial Proposal also provides sanctions for the Subject Members violation of a suspension order
The Initial Proposal provides that any sanction imposed pmsuant to proposed Rule 817 is final and immediately effective The proposed Rule dictates that the filing of an application for
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review with the SEC does not stay any sanction imposed under the rule unless the SEC orders otherwise Finally the proposed Rule permits the Subject Member who is served with a suspension order to apply to the Hearing Panel to request the order be modified set aside limited or revoked The Hearing Panel must provide an expedited response to the application within ten days
C Withdrawal and Revision of the initial Proposal
After review and consideration of comments from the public the Exchange has Vithdrawn the Initial Proposal and refiled the Revised Proposal The Revised Proposal modifies Rule 12 15 to replace the terms Layering and Spoofing with the terms Disruptive Quoting and Trading Activity Type l and Disruptive Quoting and Trading Act ivity Type 2 respectively The Revised Proposal also updates the terminology in Rules 8 17 and 12 1 5 to reflect the revised terminology of Rule 1215
In the Revised Proposal the Exchange a lso removes subparagraph ( f) of proposed Rule 8 17 contained in the Initial Proposal Subparagraph (f) provided a process for sanctioning violations of a suspension order It is the Exchanges position that a suspension order issued under Rule 8 17 is enforceable against the Subject Member and no additional process is required to discipline the violation of an order thereby making subparagraph (f) of proposed Rule 8 I 7 in the Initial Proposal superfluous
Finally the Revised proposal modifies subparagraph (d)(2)(A) of proposed Rule 81 7 to clarify that a suspension order is to order that a Member served vi th such order is suspended from access to the Exchange unless and until the Member complies with the cease and desist provisions of the order
II Conunent Letters and Response
Five Comment Letters were submitted to the SEC by four different commenters in response to the Initial Proposal Sec Letters from Samuel F Lek Chief Executive Officer Lek Securities Corporation dated September 3 2015 and September 18 201 5 (Lek Letters) Letter fro m RT Leuchtkafer dated September 4 201 5 (Leuchtkafer Letter) Letter from Mary Ami Burns Chief Operating Officer FIA Principal Traders Group dated September 9 20 I 5 ( FTA PTO Letter) and Comment from Teresa B Machado dated August 19 201 5 (Machado Comment) (co llectively the Comment Letters) The Exchange appreciates the FTA PTO Letters support of the Exchanges objecti ves and appreciates the specific concerns rai sed in the FIA PTO Letter Further the Exchange appreciates the Lek Letters and the Leuchtkafer Letters respective critiques of the Initial Proposal The Exchange also appreciates the Machado Comment s support of the Initial Proposal The Exchange responds belo to the concerns and criti cisms raised in the Comment Letters
A Definitions of Layering and Spoofing Contained in Proposed Rule 12 15
The Lek Letters raise the concern that the definitions of Layering and Spoofing in Proposed Rule I 2 15 are too broad encompassing activities that are not manipulative and
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accordingly do not violate the anti-fraud provisions of the securities laws6 The FIA PTG Letter raises the concern that the definitions of Layering and Spoofing in the Initial Proposal are overbroad and may wrongly penalize legitimate good faith actions7 Specifically the FIA PTG Letter takes issue with the lack of an express intent element in the definition of Layering and Spoofing8
On the other hand the Leuchtkafer Letter asserts that the proposed definitions of Layering and Spoofing are much too narrow9 The Leuchtkafer Letter asserts that the Proposed Rule defines Layering and Spoofing as very certain kind[ s] of act[ s] apparently exclusive of any other act[s] 10 The Leuchtkafer Letter is concerned that the proposed definitions will insulate from enforcement manipulative acts that do not fall tidily within those definitions11
The Exchange agrees that the harmful practices of layering and spoofing are defined by an intent element Indeed intent is often what distinguishes manipulative fraudulent practices from legitimate good faith behavior The Exchange acknowledged this in the Initial Proposal Proposed Rule 1215 includes an intent element by defining the respective disrnptive quoting and trading activities as a frequent pattern of the enumerated conduct Such a frequent pattern evidences manipulative intent 12
6 See September 3 2015 Lek Letter 1 The Lek Letters also lodge an array of semantic arguments against the proposed rule The Lek Letters argue that the rule is impermissibly vague because it uses the terms frequent pattern and multiple without further definition It is the Exchanges position that these terms are generally understood by their plain and ordinary meanings and therefore adequately describe the proscribed conduct
7 FIA PTG Letter 3-4 s FIA PTG Letter 3 The Lek Letters also argue that because layered orders could
theoretically be executed a trader engaged in layering could not possibly intend the orders not be executed even if he hopes that the orders do not execute September 3 2015 Lek Letter 4 This is a logical fallacy akin to arguing that a murderer did not intend to kill because although he hoped that the bullet he aimed and fired would kill his victim it was possible the bullet could miss The ultimate result of an act is not determinative of intent Neither are the possible results Instead intent is a mental slate that must exist at the time of the act in question
9 Leuchtkafer Letter 1 JO Id at 2
II Id at 3 12 The Exchange has observed that the frequent pattern of the proscribed activities is
typically the key indication of intent in layering and spoofing cases While additional corroborating information is sometimes considered to prove intent - such as contemporaneous communications or party testimony - in the Exchanges experience that
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The Leuchtkafer Letters concern that the definition of certain practices as Layering and Spoofing could be read to exclude other layering and spoofing practices is also well-taken The purpose or proposed Rule 12 15 however is not to provide universal definitions of layering and spoofing Rather once certain obvious and uncomplicated cases of disruptive and manipulative behavior or particularly harmful behavior has been identified the purpose of the proposed Rule is to initiate an expedited suspension proceeding in order to stop the behavior from continuing on the Exchange if a Member is engaging in or facilitating layering or spoofing activity and the Member has received sufficient notice vith an opportunity to respond but such activity has not ceased13 The Exchange has identified certain patterns and practices that are hallmarks of the most egregious spoofing andor layering conduct In the initial proposed Rule 12 15 the Exchange defined this conduct as Spoofing and Layering
But as discussed by the FIA PTO Letter and the Lek Letters non-spoofing and nonshylayering activity could conceivably fall within the definitions of Layering and Spoofing in the Initial Proposal and as pointed out by the Leuchtkafer Letter manipulative layering and spoofing activity could conceivably fall outside the proposed definitions Since the purpose of proposed Rules 87 and 1215 is not to provide a precise definition of layering and spoofing but to protect market participants from the harm caused by a Subject Members refusal to cease obvious disruptive market practices the Exchange has modified the defined terms in proposed Rule 1215 in the Revised Proposal The defined term Layering in initial Proposed Rule 12 15 is now labeled Disruptive Quoting and Trading Activity Type l The defined term Spoofing in the initial Proposed Rule is now labeled Disruptive Quoting and Trading Activity Type 2
The Exchange believes this change in terminology advances the objective to protect market participants from harmful manipulative behavior while alleviating both the concern that the definitions of Layering and Spoofing could insulate undefined manipulative conduct and the concern that the Proposed Rule would give the Exchange the ability to prove Layering and Spoofing v1ithout expressly proving intent This change in terminology - paired middotwith the expedited suspension order review application process - highlights that the proposed Rule 817 is a market protection rule designed to halt a very specific readily identifiable type of illegal
information typically serves only to confirm the manipulative intent indicated by a repeated pattern of disruptive activity While this corroboration Viii sti ll be obtained where available in an ultimate enfo rcement action the Exchange believes that it is unacceptable for the market to cont inue to be harmed during the time between the initial identification of manipulative intent from a frequent pattern of manipulative conduct and the discovery of corroborat ing evidence of that manipulative intent At the same time the Exchange believes that some indication of intent must exist to take action under the proposed Rules The Exchange therefore proposes to balance these competing interests by requiring a showing or a frequent pattern of disruptive activity - the most prominent badge of intent - before a suspension order may issue
See Initial Proposal Amendment No I at 5037 1
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trading activity rather than an attempt to define and punish layering and spoofing in every conceivable context 14
B Process ofExpedited Client Smpension Hearing Proceeding
Proposed Rule 817 provides a mechanism to swiHly halt egregious manipulative trading activity by Members andor clients of Members that ignore the Exchanges requests to cease the manipulative practices The Proposal provides an innovative mechanism to protect market participants from rogue clients andor Members who heretofore have been free to continue their manipulative activities pending the investigation and enforcement of their violations
The Lek Letters raise concerns regarding the expedited process for the proposed suspension proceedings15 The Lek Letters argue that the Exchange has no authority to enact the proposed Rule because the Exchange does not have jurisdiction over the clients of Members of the Exchange and that the proposed proceeding does not provide due process to a Members client that is the subject of a suspension order 16 Finally the Lek Letters argue that the proposed Expedited Client Suspension Hearing is a summary proceeding that violates the Act 17 The FIA PTO Letter on the other hand believes the Exchange s investigation notice and hearing processes described in connection with proposed Rule 817 are reasonable but suggests the process described in the Initial Proposal should be provided in an alternative format - eg as part of the proposed Rules as interpretive guidance or as FAQs 18
1 The Exchange Has Jurisdiction Over Its Members for Misconduct of a Members Client
The Lek Letters argument that the Exchange lacks jurisdiction to remedy a Members clients misconduct is mistaken As a condition of Exchange access Rule I l 3(a) requires a Member to agree to the Exchanges User Agreement which states
Except as otherwise provided herein with respect to all orders submitted to Exchange by User it is the sole responsibility of User to ensure compliance by itself its customers and its representatives with all applicable United States federal and state laws rules and regulations as well as those of FIN RA or any
14 lt is the Exchanges position that layering and spoofing are already prohibited illegal practices and at this time it is not necessary to separately define those already illegal practices See 17 CFR 240 1 Ob-5 Rule 12 1 Rule 122 The Exchange of course will revisit the issue if the need arises to specifically define layering and spoofing beyond the current generally accepted definitions of the prohibited illegal practices
15 September 3 2015 Lek Letter 5
16 kl 17 kl 18 FIA PTO Letter 2
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other self-regulatory organization of which the User is a member to the extent applicable to User User represents and warrants that it is and will remain responsible for its use of Exchange and the use of Exchange by any of its employees customers or agents or if User is a member of Exchange by any person vhich has entered into a sponsorship arrangement vith User to use Exchange (a Sponsored Participant)
Under the Exchange Rules and the User Agreement therefore a Members clients violation of the Act andor the Rules is charged to the Member
Rule 81 confers jurisdiction to the Exchange over [a] Member who is alleged to have violated or aided and abetted a violation of any provision of the Act or the rules and regulations promulgated thereunder or any provision of the Certificate oflncorporation By-Laws or Rules of the Exchange or any interpretation thereof or any resolution or order of the Board or appropriate Exchange committee The Exchange Rules therefore unquestionably confer jurisdiction to the Exchange to discipline its Members for a Members client s violations of the Act and the Exchanges Rules This jurisdiction over a Member for a clients actions is not only permissible - it is essential for the effective regulation of the Exchange 19 Because the Exchange has jurisdiction over a Member for the Members client s violations the Exchange has jurisdiction to enforce proposed Rule 817
The Lek Letters concern regarding the alleged lack of process provided to a Subject Members client is similarly misguided Because the Subject Member has ultimate responsibility for its clients actions and because proposed Rule 817 imposes discipline against the Subject Member - not the client - for the clients violations due process to the Subject Member is sufficient While the Exchange recognizes that the client may be adversely affected by the discipline against the Subject Member there is nothing in the proposed Rules that prevents a Subject Members client from participating in an expedited suspension hearing To the contrary the Exchange Velcomes the participation of the client at the hearing Because the suspension order is entered against the Subject Member however and not the client there is no due process that must be afforded the Subject Member s client
2 The Expedited Client Suspension Hearing Provides Due Process Under the Act to the Subject Member
The Lek Letters assert that the proposed expedited client suspension hearing would violate the Act because it is a summary proceeding not authorized by Section 6(d)(3) of the Act This assertion is incorrect because the proposed expedited client suspension proceeding is not a summary proceeding under Section 6(d)(3)
The Lek Letters assertion that the Exchange has no jurisdiction over a Member for a Members clients conduct would leave the Exchange helpless to enforce its own rules unless the member voluntarily cooperates with the enforcement process Such a result is obviously untenable and fli es in the face of the Exchanges obligation to enforce securities laws under the Act
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The suspension by summary proceeding permitted by Section 6(d)(3) is imposed prior to notice to the Member and an opportunity to be heard20 In contrast the proposed expedited client suspension hearing is governed by Section 6(d)(2) which provides the process for determining whether a person shall be denied membership barred from becoming associated with a member or prohibited or limited with respect to access to services offered by the exchange or a member thereof 21 As required by Section 6(d)(2) the proposed expedited client suspension hearing notif[ies] such person of and give[s] him an opportunity to be heard upon the specific grounds for denial bar or prohibition or limitation under consideration and keep[s] a record22 The expedited client suspension hearing proceeding therefore provides the clue process required under the Act
The Lek Letters also complain that the proposed expedited client suspension hearing proceeding is unfair because it does not provide sufficient time for discovery after the Exchange initiates the process As detailed in the Initial Proposal hovever the Exchange only intends to initiate the expedited client suspension hearing proceeding after an initial investigation and after the Exchange contacts the Member responsible for the orders to request an explanation of the activity and any additional relevant information Further the investigation and enforcement proceeding do not terminate upon the entry of a suspension order Discovery 1ill proceed as it would during any other enforcement action lf during the discovery process a Subject Member discovers information it believes to be exculpatory the proposed Rule allows a Subject Member [a]t any time after the [Subject Member] is served with a suspension order to apply to the Hearing Panel to have the order modified set aside limited or revoked Proposed Rule 817 merely places the burden on the Subject Member to show that it has halted its harmful practice or its clients harmful practice before being permitted to resume activity on the Exchange rather than requiring the market to bear the harm of manipulative conduct during the time-consuming discovery process Proposed Rule 817 therefore is not unfair - it is indeed fairer because it imposes the consequences of a Subject Member s harmful conduct on the Subject Member rather than imposing those consequences on the entire market
3 The Initial Proposal Clearly Defines the Parameters of Use of Proposed Rule 817
The Initial Proposal and Revised Proposal acknOmiddotVledge that the formidable power and discretion provided by proposed Rule 817 must be exercised only in the most egregious cases after a Subject Member has been given ample notice and opportunity to cease and desist the manipulative practices prohibited by the proposed Rule While the FIA PTO Letter suggests the Exchange include the process in other places the Exchange believes that the process of proposed Rule 817 and its proposed circumstances of use are clearly detailed in the Revised Proposal and would not be further clarified by repetition
20 15 USC 78f(d)(3)
21 lei at 78f( d)(2)
22 Id
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C Layering and Spoltfing Are Fraudulent Manipulative and Illegal Prnclices
Although many of the issues raised by the Lek Letters address the proposed definition of Layering and Spoofing in the Initial Proposal much of the Lek Letters argument appears to challenge the existing prohibitions in the Act against the manipulative and deceptive practices of layering and spoofing23 In fact the Lek Letters go so far as to argue that a prohibition of layering and spoofing would violate Section 6(b)(5) of the Act24
As layering and spoofing are fraudulent and manipulative practices prohibited by the Act the proposed Rules prohibiting those practices comports with Section 6(b)(5) and advances the Acts purposes Further the proposed Rules are neither anticompetitive nor unfairly discriminatory in violation of the Act as it only disciplines prohibited illegal behavior Proposed Rules 817 and I 2 I 5 therefore are consistent with the Act
III Conclusion
For the foregoing reasons the Exchange respectfully requests the Commission approve the Revised Proposal
Very truly yours
~ Anders Franzon VP Associate General Counsel
cc Stephen Luparello Director Division of Trading amp Markets David Shillman Associate Director Division ofTrading amp Markets David Liu Senior Special Counsel Division of Trading amp Markets
23 See 17 CFR 240 I Ob-5 Rule 121 Rule 122 24 September 3 2015 Lek Letter 3-6
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review with the SEC does not stay any sanction imposed under the rule unless the SEC orders otherwise Finally the proposed Rule permits the Subject Member who is served with a suspension order to apply to the Hearing Panel to request the order be modified set aside limited or revoked The Hearing Panel must provide an expedited response to the application within ten days
C Withdrawal and Revision of the initial Proposal
After review and consideration of comments from the public the Exchange has Vithdrawn the Initial Proposal and refiled the Revised Proposal The Revised Proposal modifies Rule 12 15 to replace the terms Layering and Spoofing with the terms Disruptive Quoting and Trading Activity Type l and Disruptive Quoting and Trading Act ivity Type 2 respectively The Revised Proposal also updates the terminology in Rules 8 17 and 12 1 5 to reflect the revised terminology of Rule 1215
In the Revised Proposal the Exchange a lso removes subparagraph ( f) of proposed Rule 8 17 contained in the Initial Proposal Subparagraph (f) provided a process for sanctioning violations of a suspension order It is the Exchanges position that a suspension order issued under Rule 8 17 is enforceable against the Subject Member and no additional process is required to discipline the violation of an order thereby making subparagraph (f) of proposed Rule 8 I 7 in the Initial Proposal superfluous
Finally the Revised proposal modifies subparagraph (d)(2)(A) of proposed Rule 81 7 to clarify that a suspension order is to order that a Member served vi th such order is suspended from access to the Exchange unless and until the Member complies with the cease and desist provisions of the order
II Conunent Letters and Response
Five Comment Letters were submitted to the SEC by four different commenters in response to the Initial Proposal Sec Letters from Samuel F Lek Chief Executive Officer Lek Securities Corporation dated September 3 2015 and September 18 201 5 (Lek Letters) Letter fro m RT Leuchtkafer dated September 4 201 5 (Leuchtkafer Letter) Letter from Mary Ami Burns Chief Operating Officer FIA Principal Traders Group dated September 9 20 I 5 ( FTA PTO Letter) and Comment from Teresa B Machado dated August 19 201 5 (Machado Comment) (co llectively the Comment Letters) The Exchange appreciates the FTA PTO Letters support of the Exchanges objecti ves and appreciates the specific concerns rai sed in the FIA PTO Letter Further the Exchange appreciates the Lek Letters and the Leuchtkafer Letters respective critiques of the Initial Proposal The Exchange also appreciates the Machado Comment s support of the Initial Proposal The Exchange responds belo to the concerns and criti cisms raised in the Comment Letters
A Definitions of Layering and Spoofing Contained in Proposed Rule 12 15
The Lek Letters raise the concern that the definitions of Layering and Spoofing in Proposed Rule I 2 15 are too broad encompassing activities that are not manipulative and
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accordingly do not violate the anti-fraud provisions of the securities laws6 The FIA PTG Letter raises the concern that the definitions of Layering and Spoofing in the Initial Proposal are overbroad and may wrongly penalize legitimate good faith actions7 Specifically the FIA PTG Letter takes issue with the lack of an express intent element in the definition of Layering and Spoofing8
On the other hand the Leuchtkafer Letter asserts that the proposed definitions of Layering and Spoofing are much too narrow9 The Leuchtkafer Letter asserts that the Proposed Rule defines Layering and Spoofing as very certain kind[ s] of act[ s] apparently exclusive of any other act[s] 10 The Leuchtkafer Letter is concerned that the proposed definitions will insulate from enforcement manipulative acts that do not fall tidily within those definitions11
The Exchange agrees that the harmful practices of layering and spoofing are defined by an intent element Indeed intent is often what distinguishes manipulative fraudulent practices from legitimate good faith behavior The Exchange acknowledged this in the Initial Proposal Proposed Rule 1215 includes an intent element by defining the respective disrnptive quoting and trading activities as a frequent pattern of the enumerated conduct Such a frequent pattern evidences manipulative intent 12
6 See September 3 2015 Lek Letter 1 The Lek Letters also lodge an array of semantic arguments against the proposed rule The Lek Letters argue that the rule is impermissibly vague because it uses the terms frequent pattern and multiple without further definition It is the Exchanges position that these terms are generally understood by their plain and ordinary meanings and therefore adequately describe the proscribed conduct
7 FIA PTG Letter 3-4 s FIA PTG Letter 3 The Lek Letters also argue that because layered orders could
theoretically be executed a trader engaged in layering could not possibly intend the orders not be executed even if he hopes that the orders do not execute September 3 2015 Lek Letter 4 This is a logical fallacy akin to arguing that a murderer did not intend to kill because although he hoped that the bullet he aimed and fired would kill his victim it was possible the bullet could miss The ultimate result of an act is not determinative of intent Neither are the possible results Instead intent is a mental slate that must exist at the time of the act in question
9 Leuchtkafer Letter 1 JO Id at 2
II Id at 3 12 The Exchange has observed that the frequent pattern of the proscribed activities is
typically the key indication of intent in layering and spoofing cases While additional corroborating information is sometimes considered to prove intent - such as contemporaneous communications or party testimony - in the Exchanges experience that
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The Leuchtkafer Letters concern that the definition of certain practices as Layering and Spoofing could be read to exclude other layering and spoofing practices is also well-taken The purpose or proposed Rule 12 15 however is not to provide universal definitions of layering and spoofing Rather once certain obvious and uncomplicated cases of disruptive and manipulative behavior or particularly harmful behavior has been identified the purpose of the proposed Rule is to initiate an expedited suspension proceeding in order to stop the behavior from continuing on the Exchange if a Member is engaging in or facilitating layering or spoofing activity and the Member has received sufficient notice vith an opportunity to respond but such activity has not ceased13 The Exchange has identified certain patterns and practices that are hallmarks of the most egregious spoofing andor layering conduct In the initial proposed Rule 12 15 the Exchange defined this conduct as Spoofing and Layering
But as discussed by the FIA PTO Letter and the Lek Letters non-spoofing and nonshylayering activity could conceivably fall within the definitions of Layering and Spoofing in the Initial Proposal and as pointed out by the Leuchtkafer Letter manipulative layering and spoofing activity could conceivably fall outside the proposed definitions Since the purpose of proposed Rules 87 and 1215 is not to provide a precise definition of layering and spoofing but to protect market participants from the harm caused by a Subject Members refusal to cease obvious disruptive market practices the Exchange has modified the defined terms in proposed Rule 1215 in the Revised Proposal The defined term Layering in initial Proposed Rule 12 15 is now labeled Disruptive Quoting and Trading Activity Type l The defined term Spoofing in the initial Proposed Rule is now labeled Disruptive Quoting and Trading Activity Type 2
The Exchange believes this change in terminology advances the objective to protect market participants from harmful manipulative behavior while alleviating both the concern that the definitions of Layering and Spoofing could insulate undefined manipulative conduct and the concern that the Proposed Rule would give the Exchange the ability to prove Layering and Spoofing v1ithout expressly proving intent This change in terminology - paired middotwith the expedited suspension order review application process - highlights that the proposed Rule 817 is a market protection rule designed to halt a very specific readily identifiable type of illegal
information typically serves only to confirm the manipulative intent indicated by a repeated pattern of disruptive activity While this corroboration Viii sti ll be obtained where available in an ultimate enfo rcement action the Exchange believes that it is unacceptable for the market to cont inue to be harmed during the time between the initial identification of manipulative intent from a frequent pattern of manipulative conduct and the discovery of corroborat ing evidence of that manipulative intent At the same time the Exchange believes that some indication of intent must exist to take action under the proposed Rules The Exchange therefore proposes to balance these competing interests by requiring a showing or a frequent pattern of disruptive activity - the most prominent badge of intent - before a suspension order may issue
See Initial Proposal Amendment No I at 5037 1
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trading activity rather than an attempt to define and punish layering and spoofing in every conceivable context 14
B Process ofExpedited Client Smpension Hearing Proceeding
Proposed Rule 817 provides a mechanism to swiHly halt egregious manipulative trading activity by Members andor clients of Members that ignore the Exchanges requests to cease the manipulative practices The Proposal provides an innovative mechanism to protect market participants from rogue clients andor Members who heretofore have been free to continue their manipulative activities pending the investigation and enforcement of their violations
The Lek Letters raise concerns regarding the expedited process for the proposed suspension proceedings15 The Lek Letters argue that the Exchange has no authority to enact the proposed Rule because the Exchange does not have jurisdiction over the clients of Members of the Exchange and that the proposed proceeding does not provide due process to a Members client that is the subject of a suspension order 16 Finally the Lek Letters argue that the proposed Expedited Client Suspension Hearing is a summary proceeding that violates the Act 17 The FIA PTO Letter on the other hand believes the Exchange s investigation notice and hearing processes described in connection with proposed Rule 817 are reasonable but suggests the process described in the Initial Proposal should be provided in an alternative format - eg as part of the proposed Rules as interpretive guidance or as FAQs 18
1 The Exchange Has Jurisdiction Over Its Members for Misconduct of a Members Client
The Lek Letters argument that the Exchange lacks jurisdiction to remedy a Members clients misconduct is mistaken As a condition of Exchange access Rule I l 3(a) requires a Member to agree to the Exchanges User Agreement which states
Except as otherwise provided herein with respect to all orders submitted to Exchange by User it is the sole responsibility of User to ensure compliance by itself its customers and its representatives with all applicable United States federal and state laws rules and regulations as well as those of FIN RA or any
14 lt is the Exchanges position that layering and spoofing are already prohibited illegal practices and at this time it is not necessary to separately define those already illegal practices See 17 CFR 240 1 Ob-5 Rule 12 1 Rule 122 The Exchange of course will revisit the issue if the need arises to specifically define layering and spoofing beyond the current generally accepted definitions of the prohibited illegal practices
15 September 3 2015 Lek Letter 5
16 kl 17 kl 18 FIA PTO Letter 2
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other self-regulatory organization of which the User is a member to the extent applicable to User User represents and warrants that it is and will remain responsible for its use of Exchange and the use of Exchange by any of its employees customers or agents or if User is a member of Exchange by any person vhich has entered into a sponsorship arrangement vith User to use Exchange (a Sponsored Participant)
Under the Exchange Rules and the User Agreement therefore a Members clients violation of the Act andor the Rules is charged to the Member
Rule 81 confers jurisdiction to the Exchange over [a] Member who is alleged to have violated or aided and abetted a violation of any provision of the Act or the rules and regulations promulgated thereunder or any provision of the Certificate oflncorporation By-Laws or Rules of the Exchange or any interpretation thereof or any resolution or order of the Board or appropriate Exchange committee The Exchange Rules therefore unquestionably confer jurisdiction to the Exchange to discipline its Members for a Members client s violations of the Act and the Exchanges Rules This jurisdiction over a Member for a clients actions is not only permissible - it is essential for the effective regulation of the Exchange 19 Because the Exchange has jurisdiction over a Member for the Members client s violations the Exchange has jurisdiction to enforce proposed Rule 817
The Lek Letters concern regarding the alleged lack of process provided to a Subject Members client is similarly misguided Because the Subject Member has ultimate responsibility for its clients actions and because proposed Rule 817 imposes discipline against the Subject Member - not the client - for the clients violations due process to the Subject Member is sufficient While the Exchange recognizes that the client may be adversely affected by the discipline against the Subject Member there is nothing in the proposed Rules that prevents a Subject Members client from participating in an expedited suspension hearing To the contrary the Exchange Velcomes the participation of the client at the hearing Because the suspension order is entered against the Subject Member however and not the client there is no due process that must be afforded the Subject Member s client
2 The Expedited Client Suspension Hearing Provides Due Process Under the Act to the Subject Member
The Lek Letters assert that the proposed expedited client suspension hearing would violate the Act because it is a summary proceeding not authorized by Section 6(d)(3) of the Act This assertion is incorrect because the proposed expedited client suspension proceeding is not a summary proceeding under Section 6(d)(3)
The Lek Letters assertion that the Exchange has no jurisdiction over a Member for a Members clients conduct would leave the Exchange helpless to enforce its own rules unless the member voluntarily cooperates with the enforcement process Such a result is obviously untenable and fli es in the face of the Exchanges obligation to enforce securities laws under the Act
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The suspension by summary proceeding permitted by Section 6(d)(3) is imposed prior to notice to the Member and an opportunity to be heard20 In contrast the proposed expedited client suspension hearing is governed by Section 6(d)(2) which provides the process for determining whether a person shall be denied membership barred from becoming associated with a member or prohibited or limited with respect to access to services offered by the exchange or a member thereof 21 As required by Section 6(d)(2) the proposed expedited client suspension hearing notif[ies] such person of and give[s] him an opportunity to be heard upon the specific grounds for denial bar or prohibition or limitation under consideration and keep[s] a record22 The expedited client suspension hearing proceeding therefore provides the clue process required under the Act
The Lek Letters also complain that the proposed expedited client suspension hearing proceeding is unfair because it does not provide sufficient time for discovery after the Exchange initiates the process As detailed in the Initial Proposal hovever the Exchange only intends to initiate the expedited client suspension hearing proceeding after an initial investigation and after the Exchange contacts the Member responsible for the orders to request an explanation of the activity and any additional relevant information Further the investigation and enforcement proceeding do not terminate upon the entry of a suspension order Discovery 1ill proceed as it would during any other enforcement action lf during the discovery process a Subject Member discovers information it believes to be exculpatory the proposed Rule allows a Subject Member [a]t any time after the [Subject Member] is served with a suspension order to apply to the Hearing Panel to have the order modified set aside limited or revoked Proposed Rule 817 merely places the burden on the Subject Member to show that it has halted its harmful practice or its clients harmful practice before being permitted to resume activity on the Exchange rather than requiring the market to bear the harm of manipulative conduct during the time-consuming discovery process Proposed Rule 817 therefore is not unfair - it is indeed fairer because it imposes the consequences of a Subject Member s harmful conduct on the Subject Member rather than imposing those consequences on the entire market
3 The Initial Proposal Clearly Defines the Parameters of Use of Proposed Rule 817
The Initial Proposal and Revised Proposal acknOmiddotVledge that the formidable power and discretion provided by proposed Rule 817 must be exercised only in the most egregious cases after a Subject Member has been given ample notice and opportunity to cease and desist the manipulative practices prohibited by the proposed Rule While the FIA PTO Letter suggests the Exchange include the process in other places the Exchange believes that the process of proposed Rule 817 and its proposed circumstances of use are clearly detailed in the Revised Proposal and would not be further clarified by repetition
20 15 USC 78f(d)(3)
21 lei at 78f( d)(2)
22 Id
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C Layering and Spoltfing Are Fraudulent Manipulative and Illegal Prnclices
Although many of the issues raised by the Lek Letters address the proposed definition of Layering and Spoofing in the Initial Proposal much of the Lek Letters argument appears to challenge the existing prohibitions in the Act against the manipulative and deceptive practices of layering and spoofing23 In fact the Lek Letters go so far as to argue that a prohibition of layering and spoofing would violate Section 6(b)(5) of the Act24
As layering and spoofing are fraudulent and manipulative practices prohibited by the Act the proposed Rules prohibiting those practices comports with Section 6(b)(5) and advances the Acts purposes Further the proposed Rules are neither anticompetitive nor unfairly discriminatory in violation of the Act as it only disciplines prohibited illegal behavior Proposed Rules 817 and I 2 I 5 therefore are consistent with the Act
III Conclusion
For the foregoing reasons the Exchange respectfully requests the Commission approve the Revised Proposal
Very truly yours
~ Anders Franzon VP Associate General Counsel
cc Stephen Luparello Director Division of Trading amp Markets David Shillman Associate Director Division ofTrading amp Markets David Liu Senior Special Counsel Division of Trading amp Markets
23 See 17 CFR 240 I Ob-5 Rule 121 Rule 122 24 September 3 2015 Lek Letter 3-6
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accordingly do not violate the anti-fraud provisions of the securities laws6 The FIA PTG Letter raises the concern that the definitions of Layering and Spoofing in the Initial Proposal are overbroad and may wrongly penalize legitimate good faith actions7 Specifically the FIA PTG Letter takes issue with the lack of an express intent element in the definition of Layering and Spoofing8
On the other hand the Leuchtkafer Letter asserts that the proposed definitions of Layering and Spoofing are much too narrow9 The Leuchtkafer Letter asserts that the Proposed Rule defines Layering and Spoofing as very certain kind[ s] of act[ s] apparently exclusive of any other act[s] 10 The Leuchtkafer Letter is concerned that the proposed definitions will insulate from enforcement manipulative acts that do not fall tidily within those definitions11
The Exchange agrees that the harmful practices of layering and spoofing are defined by an intent element Indeed intent is often what distinguishes manipulative fraudulent practices from legitimate good faith behavior The Exchange acknowledged this in the Initial Proposal Proposed Rule 1215 includes an intent element by defining the respective disrnptive quoting and trading activities as a frequent pattern of the enumerated conduct Such a frequent pattern evidences manipulative intent 12
6 See September 3 2015 Lek Letter 1 The Lek Letters also lodge an array of semantic arguments against the proposed rule The Lek Letters argue that the rule is impermissibly vague because it uses the terms frequent pattern and multiple without further definition It is the Exchanges position that these terms are generally understood by their plain and ordinary meanings and therefore adequately describe the proscribed conduct
7 FIA PTG Letter 3-4 s FIA PTG Letter 3 The Lek Letters also argue that because layered orders could
theoretically be executed a trader engaged in layering could not possibly intend the orders not be executed even if he hopes that the orders do not execute September 3 2015 Lek Letter 4 This is a logical fallacy akin to arguing that a murderer did not intend to kill because although he hoped that the bullet he aimed and fired would kill his victim it was possible the bullet could miss The ultimate result of an act is not determinative of intent Neither are the possible results Instead intent is a mental slate that must exist at the time of the act in question
9 Leuchtkafer Letter 1 JO Id at 2
II Id at 3 12 The Exchange has observed that the frequent pattern of the proscribed activities is
typically the key indication of intent in layering and spoofing cases While additional corroborating information is sometimes considered to prove intent - such as contemporaneous communications or party testimony - in the Exchanges experience that
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The Leuchtkafer Letters concern that the definition of certain practices as Layering and Spoofing could be read to exclude other layering and spoofing practices is also well-taken The purpose or proposed Rule 12 15 however is not to provide universal definitions of layering and spoofing Rather once certain obvious and uncomplicated cases of disruptive and manipulative behavior or particularly harmful behavior has been identified the purpose of the proposed Rule is to initiate an expedited suspension proceeding in order to stop the behavior from continuing on the Exchange if a Member is engaging in or facilitating layering or spoofing activity and the Member has received sufficient notice vith an opportunity to respond but such activity has not ceased13 The Exchange has identified certain patterns and practices that are hallmarks of the most egregious spoofing andor layering conduct In the initial proposed Rule 12 15 the Exchange defined this conduct as Spoofing and Layering
But as discussed by the FIA PTO Letter and the Lek Letters non-spoofing and nonshylayering activity could conceivably fall within the definitions of Layering and Spoofing in the Initial Proposal and as pointed out by the Leuchtkafer Letter manipulative layering and spoofing activity could conceivably fall outside the proposed definitions Since the purpose of proposed Rules 87 and 1215 is not to provide a precise definition of layering and spoofing but to protect market participants from the harm caused by a Subject Members refusal to cease obvious disruptive market practices the Exchange has modified the defined terms in proposed Rule 1215 in the Revised Proposal The defined term Layering in initial Proposed Rule 12 15 is now labeled Disruptive Quoting and Trading Activity Type l The defined term Spoofing in the initial Proposed Rule is now labeled Disruptive Quoting and Trading Activity Type 2
The Exchange believes this change in terminology advances the objective to protect market participants from harmful manipulative behavior while alleviating both the concern that the definitions of Layering and Spoofing could insulate undefined manipulative conduct and the concern that the Proposed Rule would give the Exchange the ability to prove Layering and Spoofing v1ithout expressly proving intent This change in terminology - paired middotwith the expedited suspension order review application process - highlights that the proposed Rule 817 is a market protection rule designed to halt a very specific readily identifiable type of illegal
information typically serves only to confirm the manipulative intent indicated by a repeated pattern of disruptive activity While this corroboration Viii sti ll be obtained where available in an ultimate enfo rcement action the Exchange believes that it is unacceptable for the market to cont inue to be harmed during the time between the initial identification of manipulative intent from a frequent pattern of manipulative conduct and the discovery of corroborat ing evidence of that manipulative intent At the same time the Exchange believes that some indication of intent must exist to take action under the proposed Rules The Exchange therefore proposes to balance these competing interests by requiring a showing or a frequent pattern of disruptive activity - the most prominent badge of intent - before a suspension order may issue
See Initial Proposal Amendment No I at 5037 1
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Mr Brent J Fields November 6 20 15 Page 8
trading activity rather than an attempt to define and punish layering and spoofing in every conceivable context 14
B Process ofExpedited Client Smpension Hearing Proceeding
Proposed Rule 817 provides a mechanism to swiHly halt egregious manipulative trading activity by Members andor clients of Members that ignore the Exchanges requests to cease the manipulative practices The Proposal provides an innovative mechanism to protect market participants from rogue clients andor Members who heretofore have been free to continue their manipulative activities pending the investigation and enforcement of their violations
The Lek Letters raise concerns regarding the expedited process for the proposed suspension proceedings15 The Lek Letters argue that the Exchange has no authority to enact the proposed Rule because the Exchange does not have jurisdiction over the clients of Members of the Exchange and that the proposed proceeding does not provide due process to a Members client that is the subject of a suspension order 16 Finally the Lek Letters argue that the proposed Expedited Client Suspension Hearing is a summary proceeding that violates the Act 17 The FIA PTO Letter on the other hand believes the Exchange s investigation notice and hearing processes described in connection with proposed Rule 817 are reasonable but suggests the process described in the Initial Proposal should be provided in an alternative format - eg as part of the proposed Rules as interpretive guidance or as FAQs 18
1 The Exchange Has Jurisdiction Over Its Members for Misconduct of a Members Client
The Lek Letters argument that the Exchange lacks jurisdiction to remedy a Members clients misconduct is mistaken As a condition of Exchange access Rule I l 3(a) requires a Member to agree to the Exchanges User Agreement which states
Except as otherwise provided herein with respect to all orders submitted to Exchange by User it is the sole responsibility of User to ensure compliance by itself its customers and its representatives with all applicable United States federal and state laws rules and regulations as well as those of FIN RA or any
14 lt is the Exchanges position that layering and spoofing are already prohibited illegal practices and at this time it is not necessary to separately define those already illegal practices See 17 CFR 240 1 Ob-5 Rule 12 1 Rule 122 The Exchange of course will revisit the issue if the need arises to specifically define layering and spoofing beyond the current generally accepted definitions of the prohibited illegal practices
15 September 3 2015 Lek Letter 5
16 kl 17 kl 18 FIA PTO Letter 2
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other self-regulatory organization of which the User is a member to the extent applicable to User User represents and warrants that it is and will remain responsible for its use of Exchange and the use of Exchange by any of its employees customers or agents or if User is a member of Exchange by any person vhich has entered into a sponsorship arrangement vith User to use Exchange (a Sponsored Participant)
Under the Exchange Rules and the User Agreement therefore a Members clients violation of the Act andor the Rules is charged to the Member
Rule 81 confers jurisdiction to the Exchange over [a] Member who is alleged to have violated or aided and abetted a violation of any provision of the Act or the rules and regulations promulgated thereunder or any provision of the Certificate oflncorporation By-Laws or Rules of the Exchange or any interpretation thereof or any resolution or order of the Board or appropriate Exchange committee The Exchange Rules therefore unquestionably confer jurisdiction to the Exchange to discipline its Members for a Members client s violations of the Act and the Exchanges Rules This jurisdiction over a Member for a clients actions is not only permissible - it is essential for the effective regulation of the Exchange 19 Because the Exchange has jurisdiction over a Member for the Members client s violations the Exchange has jurisdiction to enforce proposed Rule 817
The Lek Letters concern regarding the alleged lack of process provided to a Subject Members client is similarly misguided Because the Subject Member has ultimate responsibility for its clients actions and because proposed Rule 817 imposes discipline against the Subject Member - not the client - for the clients violations due process to the Subject Member is sufficient While the Exchange recognizes that the client may be adversely affected by the discipline against the Subject Member there is nothing in the proposed Rules that prevents a Subject Members client from participating in an expedited suspension hearing To the contrary the Exchange Velcomes the participation of the client at the hearing Because the suspension order is entered against the Subject Member however and not the client there is no due process that must be afforded the Subject Member s client
2 The Expedited Client Suspension Hearing Provides Due Process Under the Act to the Subject Member
The Lek Letters assert that the proposed expedited client suspension hearing would violate the Act because it is a summary proceeding not authorized by Section 6(d)(3) of the Act This assertion is incorrect because the proposed expedited client suspension proceeding is not a summary proceeding under Section 6(d)(3)
The Lek Letters assertion that the Exchange has no jurisdiction over a Member for a Members clients conduct would leave the Exchange helpless to enforce its own rules unless the member voluntarily cooperates with the enforcement process Such a result is obviously untenable and fli es in the face of the Exchanges obligation to enforce securities laws under the Act
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The suspension by summary proceeding permitted by Section 6(d)(3) is imposed prior to notice to the Member and an opportunity to be heard20 In contrast the proposed expedited client suspension hearing is governed by Section 6(d)(2) which provides the process for determining whether a person shall be denied membership barred from becoming associated with a member or prohibited or limited with respect to access to services offered by the exchange or a member thereof 21 As required by Section 6(d)(2) the proposed expedited client suspension hearing notif[ies] such person of and give[s] him an opportunity to be heard upon the specific grounds for denial bar or prohibition or limitation under consideration and keep[s] a record22 The expedited client suspension hearing proceeding therefore provides the clue process required under the Act
The Lek Letters also complain that the proposed expedited client suspension hearing proceeding is unfair because it does not provide sufficient time for discovery after the Exchange initiates the process As detailed in the Initial Proposal hovever the Exchange only intends to initiate the expedited client suspension hearing proceeding after an initial investigation and after the Exchange contacts the Member responsible for the orders to request an explanation of the activity and any additional relevant information Further the investigation and enforcement proceeding do not terminate upon the entry of a suspension order Discovery 1ill proceed as it would during any other enforcement action lf during the discovery process a Subject Member discovers information it believes to be exculpatory the proposed Rule allows a Subject Member [a]t any time after the [Subject Member] is served with a suspension order to apply to the Hearing Panel to have the order modified set aside limited or revoked Proposed Rule 817 merely places the burden on the Subject Member to show that it has halted its harmful practice or its clients harmful practice before being permitted to resume activity on the Exchange rather than requiring the market to bear the harm of manipulative conduct during the time-consuming discovery process Proposed Rule 817 therefore is not unfair - it is indeed fairer because it imposes the consequences of a Subject Member s harmful conduct on the Subject Member rather than imposing those consequences on the entire market
3 The Initial Proposal Clearly Defines the Parameters of Use of Proposed Rule 817
The Initial Proposal and Revised Proposal acknOmiddotVledge that the formidable power and discretion provided by proposed Rule 817 must be exercised only in the most egregious cases after a Subject Member has been given ample notice and opportunity to cease and desist the manipulative practices prohibited by the proposed Rule While the FIA PTO Letter suggests the Exchange include the process in other places the Exchange believes that the process of proposed Rule 817 and its proposed circumstances of use are clearly detailed in the Revised Proposal and would not be further clarified by repetition
20 15 USC 78f(d)(3)
21 lei at 78f( d)(2)
22 Id
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C Layering and Spoltfing Are Fraudulent Manipulative and Illegal Prnclices
Although many of the issues raised by the Lek Letters address the proposed definition of Layering and Spoofing in the Initial Proposal much of the Lek Letters argument appears to challenge the existing prohibitions in the Act against the manipulative and deceptive practices of layering and spoofing23 In fact the Lek Letters go so far as to argue that a prohibition of layering and spoofing would violate Section 6(b)(5) of the Act24
As layering and spoofing are fraudulent and manipulative practices prohibited by the Act the proposed Rules prohibiting those practices comports with Section 6(b)(5) and advances the Acts purposes Further the proposed Rules are neither anticompetitive nor unfairly discriminatory in violation of the Act as it only disciplines prohibited illegal behavior Proposed Rules 817 and I 2 I 5 therefore are consistent with the Act
III Conclusion
For the foregoing reasons the Exchange respectfully requests the Commission approve the Revised Proposal
Very truly yours
~ Anders Franzon VP Associate General Counsel
cc Stephen Luparello Director Division of Trading amp Markets David Shillman Associate Director Division ofTrading amp Markets David Liu Senior Special Counsel Division of Trading amp Markets
23 See 17 CFR 240 I Ob-5 Rule 121 Rule 122 24 September 3 2015 Lek Letter 3-6
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The Leuchtkafer Letters concern that the definition of certain practices as Layering and Spoofing could be read to exclude other layering and spoofing practices is also well-taken The purpose or proposed Rule 12 15 however is not to provide universal definitions of layering and spoofing Rather once certain obvious and uncomplicated cases of disruptive and manipulative behavior or particularly harmful behavior has been identified the purpose of the proposed Rule is to initiate an expedited suspension proceeding in order to stop the behavior from continuing on the Exchange if a Member is engaging in or facilitating layering or spoofing activity and the Member has received sufficient notice vith an opportunity to respond but such activity has not ceased13 The Exchange has identified certain patterns and practices that are hallmarks of the most egregious spoofing andor layering conduct In the initial proposed Rule 12 15 the Exchange defined this conduct as Spoofing and Layering
But as discussed by the FIA PTO Letter and the Lek Letters non-spoofing and nonshylayering activity could conceivably fall within the definitions of Layering and Spoofing in the Initial Proposal and as pointed out by the Leuchtkafer Letter manipulative layering and spoofing activity could conceivably fall outside the proposed definitions Since the purpose of proposed Rules 87 and 1215 is not to provide a precise definition of layering and spoofing but to protect market participants from the harm caused by a Subject Members refusal to cease obvious disruptive market practices the Exchange has modified the defined terms in proposed Rule 1215 in the Revised Proposal The defined term Layering in initial Proposed Rule 12 15 is now labeled Disruptive Quoting and Trading Activity Type l The defined term Spoofing in the initial Proposed Rule is now labeled Disruptive Quoting and Trading Activity Type 2
The Exchange believes this change in terminology advances the objective to protect market participants from harmful manipulative behavior while alleviating both the concern that the definitions of Layering and Spoofing could insulate undefined manipulative conduct and the concern that the Proposed Rule would give the Exchange the ability to prove Layering and Spoofing v1ithout expressly proving intent This change in terminology - paired middotwith the expedited suspension order review application process - highlights that the proposed Rule 817 is a market protection rule designed to halt a very specific readily identifiable type of illegal
information typically serves only to confirm the manipulative intent indicated by a repeated pattern of disruptive activity While this corroboration Viii sti ll be obtained where available in an ultimate enfo rcement action the Exchange believes that it is unacceptable for the market to cont inue to be harmed during the time between the initial identification of manipulative intent from a frequent pattern of manipulative conduct and the discovery of corroborat ing evidence of that manipulative intent At the same time the Exchange believes that some indication of intent must exist to take action under the proposed Rules The Exchange therefore proposes to balance these competing interests by requiring a showing or a frequent pattern of disruptive activity - the most prominent badge of intent - before a suspension order may issue
See Initial Proposal Amendment No I at 5037 1
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13
Mr Brent J Fields November 6 20 15 Page 8
trading activity rather than an attempt to define and punish layering and spoofing in every conceivable context 14
B Process ofExpedited Client Smpension Hearing Proceeding
Proposed Rule 817 provides a mechanism to swiHly halt egregious manipulative trading activity by Members andor clients of Members that ignore the Exchanges requests to cease the manipulative practices The Proposal provides an innovative mechanism to protect market participants from rogue clients andor Members who heretofore have been free to continue their manipulative activities pending the investigation and enforcement of their violations
The Lek Letters raise concerns regarding the expedited process for the proposed suspension proceedings15 The Lek Letters argue that the Exchange has no authority to enact the proposed Rule because the Exchange does not have jurisdiction over the clients of Members of the Exchange and that the proposed proceeding does not provide due process to a Members client that is the subject of a suspension order 16 Finally the Lek Letters argue that the proposed Expedited Client Suspension Hearing is a summary proceeding that violates the Act 17 The FIA PTO Letter on the other hand believes the Exchange s investigation notice and hearing processes described in connection with proposed Rule 817 are reasonable but suggests the process described in the Initial Proposal should be provided in an alternative format - eg as part of the proposed Rules as interpretive guidance or as FAQs 18
1 The Exchange Has Jurisdiction Over Its Members for Misconduct of a Members Client
The Lek Letters argument that the Exchange lacks jurisdiction to remedy a Members clients misconduct is mistaken As a condition of Exchange access Rule I l 3(a) requires a Member to agree to the Exchanges User Agreement which states
Except as otherwise provided herein with respect to all orders submitted to Exchange by User it is the sole responsibility of User to ensure compliance by itself its customers and its representatives with all applicable United States federal and state laws rules and regulations as well as those of FIN RA or any
14 lt is the Exchanges position that layering and spoofing are already prohibited illegal practices and at this time it is not necessary to separately define those already illegal practices See 17 CFR 240 1 Ob-5 Rule 12 1 Rule 122 The Exchange of course will revisit the issue if the need arises to specifically define layering and spoofing beyond the current generally accepted definitions of the prohibited illegal practices
15 September 3 2015 Lek Letter 5
16 kl 17 kl 18 FIA PTO Letter 2
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other self-regulatory organization of which the User is a member to the extent applicable to User User represents and warrants that it is and will remain responsible for its use of Exchange and the use of Exchange by any of its employees customers or agents or if User is a member of Exchange by any person vhich has entered into a sponsorship arrangement vith User to use Exchange (a Sponsored Participant)
Under the Exchange Rules and the User Agreement therefore a Members clients violation of the Act andor the Rules is charged to the Member
Rule 81 confers jurisdiction to the Exchange over [a] Member who is alleged to have violated or aided and abetted a violation of any provision of the Act or the rules and regulations promulgated thereunder or any provision of the Certificate oflncorporation By-Laws or Rules of the Exchange or any interpretation thereof or any resolution or order of the Board or appropriate Exchange committee The Exchange Rules therefore unquestionably confer jurisdiction to the Exchange to discipline its Members for a Members client s violations of the Act and the Exchanges Rules This jurisdiction over a Member for a clients actions is not only permissible - it is essential for the effective regulation of the Exchange 19 Because the Exchange has jurisdiction over a Member for the Members client s violations the Exchange has jurisdiction to enforce proposed Rule 817
The Lek Letters concern regarding the alleged lack of process provided to a Subject Members client is similarly misguided Because the Subject Member has ultimate responsibility for its clients actions and because proposed Rule 817 imposes discipline against the Subject Member - not the client - for the clients violations due process to the Subject Member is sufficient While the Exchange recognizes that the client may be adversely affected by the discipline against the Subject Member there is nothing in the proposed Rules that prevents a Subject Members client from participating in an expedited suspension hearing To the contrary the Exchange Velcomes the participation of the client at the hearing Because the suspension order is entered against the Subject Member however and not the client there is no due process that must be afforded the Subject Member s client
2 The Expedited Client Suspension Hearing Provides Due Process Under the Act to the Subject Member
The Lek Letters assert that the proposed expedited client suspension hearing would violate the Act because it is a summary proceeding not authorized by Section 6(d)(3) of the Act This assertion is incorrect because the proposed expedited client suspension proceeding is not a summary proceeding under Section 6(d)(3)
The Lek Letters assertion that the Exchange has no jurisdiction over a Member for a Members clients conduct would leave the Exchange helpless to enforce its own rules unless the member voluntarily cooperates with the enforcement process Such a result is obviously untenable and fli es in the face of the Exchanges obligation to enforce securities laws under the Act
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The suspension by summary proceeding permitted by Section 6(d)(3) is imposed prior to notice to the Member and an opportunity to be heard20 In contrast the proposed expedited client suspension hearing is governed by Section 6(d)(2) which provides the process for determining whether a person shall be denied membership barred from becoming associated with a member or prohibited or limited with respect to access to services offered by the exchange or a member thereof 21 As required by Section 6(d)(2) the proposed expedited client suspension hearing notif[ies] such person of and give[s] him an opportunity to be heard upon the specific grounds for denial bar or prohibition or limitation under consideration and keep[s] a record22 The expedited client suspension hearing proceeding therefore provides the clue process required under the Act
The Lek Letters also complain that the proposed expedited client suspension hearing proceeding is unfair because it does not provide sufficient time for discovery after the Exchange initiates the process As detailed in the Initial Proposal hovever the Exchange only intends to initiate the expedited client suspension hearing proceeding after an initial investigation and after the Exchange contacts the Member responsible for the orders to request an explanation of the activity and any additional relevant information Further the investigation and enforcement proceeding do not terminate upon the entry of a suspension order Discovery 1ill proceed as it would during any other enforcement action lf during the discovery process a Subject Member discovers information it believes to be exculpatory the proposed Rule allows a Subject Member [a]t any time after the [Subject Member] is served with a suspension order to apply to the Hearing Panel to have the order modified set aside limited or revoked Proposed Rule 817 merely places the burden on the Subject Member to show that it has halted its harmful practice or its clients harmful practice before being permitted to resume activity on the Exchange rather than requiring the market to bear the harm of manipulative conduct during the time-consuming discovery process Proposed Rule 817 therefore is not unfair - it is indeed fairer because it imposes the consequences of a Subject Member s harmful conduct on the Subject Member rather than imposing those consequences on the entire market
3 The Initial Proposal Clearly Defines the Parameters of Use of Proposed Rule 817
The Initial Proposal and Revised Proposal acknOmiddotVledge that the formidable power and discretion provided by proposed Rule 817 must be exercised only in the most egregious cases after a Subject Member has been given ample notice and opportunity to cease and desist the manipulative practices prohibited by the proposed Rule While the FIA PTO Letter suggests the Exchange include the process in other places the Exchange believes that the process of proposed Rule 817 and its proposed circumstances of use are clearly detailed in the Revised Proposal and would not be further clarified by repetition
20 15 USC 78f(d)(3)
21 lei at 78f( d)(2)
22 Id
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C Layering and Spoltfing Are Fraudulent Manipulative and Illegal Prnclices
Although many of the issues raised by the Lek Letters address the proposed definition of Layering and Spoofing in the Initial Proposal much of the Lek Letters argument appears to challenge the existing prohibitions in the Act against the manipulative and deceptive practices of layering and spoofing23 In fact the Lek Letters go so far as to argue that a prohibition of layering and spoofing would violate Section 6(b)(5) of the Act24
As layering and spoofing are fraudulent and manipulative practices prohibited by the Act the proposed Rules prohibiting those practices comports with Section 6(b)(5) and advances the Acts purposes Further the proposed Rules are neither anticompetitive nor unfairly discriminatory in violation of the Act as it only disciplines prohibited illegal behavior Proposed Rules 817 and I 2 I 5 therefore are consistent with the Act
III Conclusion
For the foregoing reasons the Exchange respectfully requests the Commission approve the Revised Proposal
Very truly yours
~ Anders Franzon VP Associate General Counsel
cc Stephen Luparello Director Division of Trading amp Markets David Shillman Associate Director Division ofTrading amp Markets David Liu Senior Special Counsel Division of Trading amp Markets
23 See 17 CFR 240 I Ob-5 Rule 121 Rule 122 24 September 3 2015 Lek Letter 3-6
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trading activity rather than an attempt to define and punish layering and spoofing in every conceivable context 14
B Process ofExpedited Client Smpension Hearing Proceeding
Proposed Rule 817 provides a mechanism to swiHly halt egregious manipulative trading activity by Members andor clients of Members that ignore the Exchanges requests to cease the manipulative practices The Proposal provides an innovative mechanism to protect market participants from rogue clients andor Members who heretofore have been free to continue their manipulative activities pending the investigation and enforcement of their violations
The Lek Letters raise concerns regarding the expedited process for the proposed suspension proceedings15 The Lek Letters argue that the Exchange has no authority to enact the proposed Rule because the Exchange does not have jurisdiction over the clients of Members of the Exchange and that the proposed proceeding does not provide due process to a Members client that is the subject of a suspension order 16 Finally the Lek Letters argue that the proposed Expedited Client Suspension Hearing is a summary proceeding that violates the Act 17 The FIA PTO Letter on the other hand believes the Exchange s investigation notice and hearing processes described in connection with proposed Rule 817 are reasonable but suggests the process described in the Initial Proposal should be provided in an alternative format - eg as part of the proposed Rules as interpretive guidance or as FAQs 18
1 The Exchange Has Jurisdiction Over Its Members for Misconduct of a Members Client
The Lek Letters argument that the Exchange lacks jurisdiction to remedy a Members clients misconduct is mistaken As a condition of Exchange access Rule I l 3(a) requires a Member to agree to the Exchanges User Agreement which states
Except as otherwise provided herein with respect to all orders submitted to Exchange by User it is the sole responsibility of User to ensure compliance by itself its customers and its representatives with all applicable United States federal and state laws rules and regulations as well as those of FIN RA or any
14 lt is the Exchanges position that layering and spoofing are already prohibited illegal practices and at this time it is not necessary to separately define those already illegal practices See 17 CFR 240 1 Ob-5 Rule 12 1 Rule 122 The Exchange of course will revisit the issue if the need arises to specifically define layering and spoofing beyond the current generally accepted definitions of the prohibited illegal practices
15 September 3 2015 Lek Letter 5
16 kl 17 kl 18 FIA PTO Letter 2
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other self-regulatory organization of which the User is a member to the extent applicable to User User represents and warrants that it is and will remain responsible for its use of Exchange and the use of Exchange by any of its employees customers or agents or if User is a member of Exchange by any person vhich has entered into a sponsorship arrangement vith User to use Exchange (a Sponsored Participant)
Under the Exchange Rules and the User Agreement therefore a Members clients violation of the Act andor the Rules is charged to the Member
Rule 81 confers jurisdiction to the Exchange over [a] Member who is alleged to have violated or aided and abetted a violation of any provision of the Act or the rules and regulations promulgated thereunder or any provision of the Certificate oflncorporation By-Laws or Rules of the Exchange or any interpretation thereof or any resolution or order of the Board or appropriate Exchange committee The Exchange Rules therefore unquestionably confer jurisdiction to the Exchange to discipline its Members for a Members client s violations of the Act and the Exchanges Rules This jurisdiction over a Member for a clients actions is not only permissible - it is essential for the effective regulation of the Exchange 19 Because the Exchange has jurisdiction over a Member for the Members client s violations the Exchange has jurisdiction to enforce proposed Rule 817
The Lek Letters concern regarding the alleged lack of process provided to a Subject Members client is similarly misguided Because the Subject Member has ultimate responsibility for its clients actions and because proposed Rule 817 imposes discipline against the Subject Member - not the client - for the clients violations due process to the Subject Member is sufficient While the Exchange recognizes that the client may be adversely affected by the discipline against the Subject Member there is nothing in the proposed Rules that prevents a Subject Members client from participating in an expedited suspension hearing To the contrary the Exchange Velcomes the participation of the client at the hearing Because the suspension order is entered against the Subject Member however and not the client there is no due process that must be afforded the Subject Member s client
2 The Expedited Client Suspension Hearing Provides Due Process Under the Act to the Subject Member
The Lek Letters assert that the proposed expedited client suspension hearing would violate the Act because it is a summary proceeding not authorized by Section 6(d)(3) of the Act This assertion is incorrect because the proposed expedited client suspension proceeding is not a summary proceeding under Section 6(d)(3)
The Lek Letters assertion that the Exchange has no jurisdiction over a Member for a Members clients conduct would leave the Exchange helpless to enforce its own rules unless the member voluntarily cooperates with the enforcement process Such a result is obviously untenable and fli es in the face of the Exchanges obligation to enforce securities laws under the Act
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The suspension by summary proceeding permitted by Section 6(d)(3) is imposed prior to notice to the Member and an opportunity to be heard20 In contrast the proposed expedited client suspension hearing is governed by Section 6(d)(2) which provides the process for determining whether a person shall be denied membership barred from becoming associated with a member or prohibited or limited with respect to access to services offered by the exchange or a member thereof 21 As required by Section 6(d)(2) the proposed expedited client suspension hearing notif[ies] such person of and give[s] him an opportunity to be heard upon the specific grounds for denial bar or prohibition or limitation under consideration and keep[s] a record22 The expedited client suspension hearing proceeding therefore provides the clue process required under the Act
The Lek Letters also complain that the proposed expedited client suspension hearing proceeding is unfair because it does not provide sufficient time for discovery after the Exchange initiates the process As detailed in the Initial Proposal hovever the Exchange only intends to initiate the expedited client suspension hearing proceeding after an initial investigation and after the Exchange contacts the Member responsible for the orders to request an explanation of the activity and any additional relevant information Further the investigation and enforcement proceeding do not terminate upon the entry of a suspension order Discovery 1ill proceed as it would during any other enforcement action lf during the discovery process a Subject Member discovers information it believes to be exculpatory the proposed Rule allows a Subject Member [a]t any time after the [Subject Member] is served with a suspension order to apply to the Hearing Panel to have the order modified set aside limited or revoked Proposed Rule 817 merely places the burden on the Subject Member to show that it has halted its harmful practice or its clients harmful practice before being permitted to resume activity on the Exchange rather than requiring the market to bear the harm of manipulative conduct during the time-consuming discovery process Proposed Rule 817 therefore is not unfair - it is indeed fairer because it imposes the consequences of a Subject Member s harmful conduct on the Subject Member rather than imposing those consequences on the entire market
3 The Initial Proposal Clearly Defines the Parameters of Use of Proposed Rule 817
The Initial Proposal and Revised Proposal acknOmiddotVledge that the formidable power and discretion provided by proposed Rule 817 must be exercised only in the most egregious cases after a Subject Member has been given ample notice and opportunity to cease and desist the manipulative practices prohibited by the proposed Rule While the FIA PTO Letter suggests the Exchange include the process in other places the Exchange believes that the process of proposed Rule 817 and its proposed circumstances of use are clearly detailed in the Revised Proposal and would not be further clarified by repetition
20 15 USC 78f(d)(3)
21 lei at 78f( d)(2)
22 Id
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C Layering and Spoltfing Are Fraudulent Manipulative and Illegal Prnclices
Although many of the issues raised by the Lek Letters address the proposed definition of Layering and Spoofing in the Initial Proposal much of the Lek Letters argument appears to challenge the existing prohibitions in the Act against the manipulative and deceptive practices of layering and spoofing23 In fact the Lek Letters go so far as to argue that a prohibition of layering and spoofing would violate Section 6(b)(5) of the Act24
As layering and spoofing are fraudulent and manipulative practices prohibited by the Act the proposed Rules prohibiting those practices comports with Section 6(b)(5) and advances the Acts purposes Further the proposed Rules are neither anticompetitive nor unfairly discriminatory in violation of the Act as it only disciplines prohibited illegal behavior Proposed Rules 817 and I 2 I 5 therefore are consistent with the Act
III Conclusion
For the foregoing reasons the Exchange respectfully requests the Commission approve the Revised Proposal
Very truly yours
~ Anders Franzon VP Associate General Counsel
cc Stephen Luparello Director Division of Trading amp Markets David Shillman Associate Director Division ofTrading amp Markets David Liu Senior Special Counsel Division of Trading amp Markets
23 See 17 CFR 240 I Ob-5 Rule 121 Rule 122 24 September 3 2015 Lek Letter 3-6
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other self-regulatory organization of which the User is a member to the extent applicable to User User represents and warrants that it is and will remain responsible for its use of Exchange and the use of Exchange by any of its employees customers or agents or if User is a member of Exchange by any person vhich has entered into a sponsorship arrangement vith User to use Exchange (a Sponsored Participant)
Under the Exchange Rules and the User Agreement therefore a Members clients violation of the Act andor the Rules is charged to the Member
Rule 81 confers jurisdiction to the Exchange over [a] Member who is alleged to have violated or aided and abetted a violation of any provision of the Act or the rules and regulations promulgated thereunder or any provision of the Certificate oflncorporation By-Laws or Rules of the Exchange or any interpretation thereof or any resolution or order of the Board or appropriate Exchange committee The Exchange Rules therefore unquestionably confer jurisdiction to the Exchange to discipline its Members for a Members client s violations of the Act and the Exchanges Rules This jurisdiction over a Member for a clients actions is not only permissible - it is essential for the effective regulation of the Exchange 19 Because the Exchange has jurisdiction over a Member for the Members client s violations the Exchange has jurisdiction to enforce proposed Rule 817
The Lek Letters concern regarding the alleged lack of process provided to a Subject Members client is similarly misguided Because the Subject Member has ultimate responsibility for its clients actions and because proposed Rule 817 imposes discipline against the Subject Member - not the client - for the clients violations due process to the Subject Member is sufficient While the Exchange recognizes that the client may be adversely affected by the discipline against the Subject Member there is nothing in the proposed Rules that prevents a Subject Members client from participating in an expedited suspension hearing To the contrary the Exchange Velcomes the participation of the client at the hearing Because the suspension order is entered against the Subject Member however and not the client there is no due process that must be afforded the Subject Member s client
2 The Expedited Client Suspension Hearing Provides Due Process Under the Act to the Subject Member
The Lek Letters assert that the proposed expedited client suspension hearing would violate the Act because it is a summary proceeding not authorized by Section 6(d)(3) of the Act This assertion is incorrect because the proposed expedited client suspension proceeding is not a summary proceeding under Section 6(d)(3)
The Lek Letters assertion that the Exchange has no jurisdiction over a Member for a Members clients conduct would leave the Exchange helpless to enforce its own rules unless the member voluntarily cooperates with the enforcement process Such a result is obviously untenable and fli es in the face of the Exchanges obligation to enforce securities laws under the Act
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The suspension by summary proceeding permitted by Section 6(d)(3) is imposed prior to notice to the Member and an opportunity to be heard20 In contrast the proposed expedited client suspension hearing is governed by Section 6(d)(2) which provides the process for determining whether a person shall be denied membership barred from becoming associated with a member or prohibited or limited with respect to access to services offered by the exchange or a member thereof 21 As required by Section 6(d)(2) the proposed expedited client suspension hearing notif[ies] such person of and give[s] him an opportunity to be heard upon the specific grounds for denial bar or prohibition or limitation under consideration and keep[s] a record22 The expedited client suspension hearing proceeding therefore provides the clue process required under the Act
The Lek Letters also complain that the proposed expedited client suspension hearing proceeding is unfair because it does not provide sufficient time for discovery after the Exchange initiates the process As detailed in the Initial Proposal hovever the Exchange only intends to initiate the expedited client suspension hearing proceeding after an initial investigation and after the Exchange contacts the Member responsible for the orders to request an explanation of the activity and any additional relevant information Further the investigation and enforcement proceeding do not terminate upon the entry of a suspension order Discovery 1ill proceed as it would during any other enforcement action lf during the discovery process a Subject Member discovers information it believes to be exculpatory the proposed Rule allows a Subject Member [a]t any time after the [Subject Member] is served with a suspension order to apply to the Hearing Panel to have the order modified set aside limited or revoked Proposed Rule 817 merely places the burden on the Subject Member to show that it has halted its harmful practice or its clients harmful practice before being permitted to resume activity on the Exchange rather than requiring the market to bear the harm of manipulative conduct during the time-consuming discovery process Proposed Rule 817 therefore is not unfair - it is indeed fairer because it imposes the consequences of a Subject Member s harmful conduct on the Subject Member rather than imposing those consequences on the entire market
3 The Initial Proposal Clearly Defines the Parameters of Use of Proposed Rule 817
The Initial Proposal and Revised Proposal acknOmiddotVledge that the formidable power and discretion provided by proposed Rule 817 must be exercised only in the most egregious cases after a Subject Member has been given ample notice and opportunity to cease and desist the manipulative practices prohibited by the proposed Rule While the FIA PTO Letter suggests the Exchange include the process in other places the Exchange believes that the process of proposed Rule 817 and its proposed circumstances of use are clearly detailed in the Revised Proposal and would not be further clarified by repetition
20 15 USC 78f(d)(3)
21 lei at 78f( d)(2)
22 Id
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C Layering and Spoltfing Are Fraudulent Manipulative and Illegal Prnclices
Although many of the issues raised by the Lek Letters address the proposed definition of Layering and Spoofing in the Initial Proposal much of the Lek Letters argument appears to challenge the existing prohibitions in the Act against the manipulative and deceptive practices of layering and spoofing23 In fact the Lek Letters go so far as to argue that a prohibition of layering and spoofing would violate Section 6(b)(5) of the Act24
As layering and spoofing are fraudulent and manipulative practices prohibited by the Act the proposed Rules prohibiting those practices comports with Section 6(b)(5) and advances the Acts purposes Further the proposed Rules are neither anticompetitive nor unfairly discriminatory in violation of the Act as it only disciplines prohibited illegal behavior Proposed Rules 817 and I 2 I 5 therefore are consistent with the Act
III Conclusion
For the foregoing reasons the Exchange respectfully requests the Commission approve the Revised Proposal
Very truly yours
~ Anders Franzon VP Associate General Counsel
cc Stephen Luparello Director Division of Trading amp Markets David Shillman Associate Director Division ofTrading amp Markets David Liu Senior Special Counsel Division of Trading amp Markets
23 See 17 CFR 240 I Ob-5 Rule 121 Rule 122 24 September 3 2015 Lek Letter 3-6
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The suspension by summary proceeding permitted by Section 6(d)(3) is imposed prior to notice to the Member and an opportunity to be heard20 In contrast the proposed expedited client suspension hearing is governed by Section 6(d)(2) which provides the process for determining whether a person shall be denied membership barred from becoming associated with a member or prohibited or limited with respect to access to services offered by the exchange or a member thereof 21 As required by Section 6(d)(2) the proposed expedited client suspension hearing notif[ies] such person of and give[s] him an opportunity to be heard upon the specific grounds for denial bar or prohibition or limitation under consideration and keep[s] a record22 The expedited client suspension hearing proceeding therefore provides the clue process required under the Act
The Lek Letters also complain that the proposed expedited client suspension hearing proceeding is unfair because it does not provide sufficient time for discovery after the Exchange initiates the process As detailed in the Initial Proposal hovever the Exchange only intends to initiate the expedited client suspension hearing proceeding after an initial investigation and after the Exchange contacts the Member responsible for the orders to request an explanation of the activity and any additional relevant information Further the investigation and enforcement proceeding do not terminate upon the entry of a suspension order Discovery 1ill proceed as it would during any other enforcement action lf during the discovery process a Subject Member discovers information it believes to be exculpatory the proposed Rule allows a Subject Member [a]t any time after the [Subject Member] is served with a suspension order to apply to the Hearing Panel to have the order modified set aside limited or revoked Proposed Rule 817 merely places the burden on the Subject Member to show that it has halted its harmful practice or its clients harmful practice before being permitted to resume activity on the Exchange rather than requiring the market to bear the harm of manipulative conduct during the time-consuming discovery process Proposed Rule 817 therefore is not unfair - it is indeed fairer because it imposes the consequences of a Subject Member s harmful conduct on the Subject Member rather than imposing those consequences on the entire market
3 The Initial Proposal Clearly Defines the Parameters of Use of Proposed Rule 817
The Initial Proposal and Revised Proposal acknOmiddotVledge that the formidable power and discretion provided by proposed Rule 817 must be exercised only in the most egregious cases after a Subject Member has been given ample notice and opportunity to cease and desist the manipulative practices prohibited by the proposed Rule While the FIA PTO Letter suggests the Exchange include the process in other places the Exchange believes that the process of proposed Rule 817 and its proposed circumstances of use are clearly detailed in the Revised Proposal and would not be further clarified by repetition
20 15 USC 78f(d)(3)
21 lei at 78f( d)(2)
22 Id
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C Layering and Spoltfing Are Fraudulent Manipulative and Illegal Prnclices
Although many of the issues raised by the Lek Letters address the proposed definition of Layering and Spoofing in the Initial Proposal much of the Lek Letters argument appears to challenge the existing prohibitions in the Act against the manipulative and deceptive practices of layering and spoofing23 In fact the Lek Letters go so far as to argue that a prohibition of layering and spoofing would violate Section 6(b)(5) of the Act24
As layering and spoofing are fraudulent and manipulative practices prohibited by the Act the proposed Rules prohibiting those practices comports with Section 6(b)(5) and advances the Acts purposes Further the proposed Rules are neither anticompetitive nor unfairly discriminatory in violation of the Act as it only disciplines prohibited illegal behavior Proposed Rules 817 and I 2 I 5 therefore are consistent with the Act
III Conclusion
For the foregoing reasons the Exchange respectfully requests the Commission approve the Revised Proposal
Very truly yours
~ Anders Franzon VP Associate General Counsel
cc Stephen Luparello Director Division of Trading amp Markets David Shillman Associate Director Division ofTrading amp Markets David Liu Senior Special Counsel Division of Trading amp Markets
23 See 17 CFR 240 I Ob-5 Rule 121 Rule 122 24 September 3 2015 Lek Letter 3-6
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C Layering and Spoltfing Are Fraudulent Manipulative and Illegal Prnclices
Although many of the issues raised by the Lek Letters address the proposed definition of Layering and Spoofing in the Initial Proposal much of the Lek Letters argument appears to challenge the existing prohibitions in the Act against the manipulative and deceptive practices of layering and spoofing23 In fact the Lek Letters go so far as to argue that a prohibition of layering and spoofing would violate Section 6(b)(5) of the Act24
As layering and spoofing are fraudulent and manipulative practices prohibited by the Act the proposed Rules prohibiting those practices comports with Section 6(b)(5) and advances the Acts purposes Further the proposed Rules are neither anticompetitive nor unfairly discriminatory in violation of the Act as it only disciplines prohibited illegal behavior Proposed Rules 817 and I 2 I 5 therefore are consistent with the Act
III Conclusion
For the foregoing reasons the Exchange respectfully requests the Commission approve the Revised Proposal
Very truly yours
~ Anders Franzon VP Associate General Counsel
cc Stephen Luparello Director Division of Trading amp Markets David Shillman Associate Director Division ofTrading amp Markets David Liu Senior Special Counsel Division of Trading amp Markets
23 See 17 CFR 240 I Ob-5 Rule 121 Rule 122 24 September 3 2015 Lek Letter 3-6
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